Subject-To’s vs. Wraparound Mortgages – What’s the difference?


Many investors have asked me to explain the difference between “Subject-Tos” and “Wraparound Mortgages.”

Both are very useful types of financing that can help you get a deal done when conventional financing isn’t possible, without having to use expensive hard money.

Subject-To’s (short for “Subject To the Existing Financing”) are deals where the buyer purchases a property subject to the existing mortgage. The buyer will acquire the property and take over the payments of the existing mortgage. The seller and buyer will make an agreement and the seller will hand over the payment booklet to the buyer. There is no new mortgage. Subject-To’s are often used when the seller is behind on their mortgage.

In other words, when you purchase a home subject to real estate, you are responsible for the payments on the loan. The seller will deed the property over to you, so you will officially be the owner of the home, but the mortgage will stay in the seller’s name.

You are offering them a way to sell the home, pass the loan to you, and take some cash away from the deal. They will have concerns about their liability for the loan, so you may have to set up a payment system that allows them to monitor your prompt payments. You can also assure them that your investment, the down payment, is something you don’t want to lose by going into default.

One thing to be aware of when buying a property Subject-To is the Due-On-Sale clause. Most mortgages have a due-on-sale clause that states the balance of the loan is due if the property is sold. Normally, this would mean the seller has to payoff the loan when the property is sold. However, banks rarely enforce this clause. As long as the mortgage is still being payed, the banks are usually happy. Remember: banks don’t want homes to go to foreclosure, as they are not in the business of buying/selling real estate. So, while you need to be aware of the Due-On-Sale clause, it usually isn’t an issue.

A Wraparound Mortgage or a Wrap (can also be called, All Inclusive Trust Deed (AITD)) is commonly used when you sell a property that you have an existing mortgage on and are willing to owner finance. You set the terms of the new loan so that the buyer is making you a monthly payment that is higher than your current payment on your existing mortgage. Therefore, the buyer is making you a payment which you will use to pay your mortgage, thus the “Wraparound.” The difference between their payment and your payment is your monthly cashflow.

Here is an example:

The Smiths have a $70,000 mortgage on their home. They sell it to you for $100,000. You pay $5,000 down and then borrow $95,000 on a new mortgage that they grant you. This new mortgage “wraps around” their original $70,000 mortgage because there are still payments to be made on the old mortgage.

So, what are the main advantages to you as an investor?

The first is leverage. Here’s an example to illustrate how you gain leverage with a wrap-around mortgage:

Assume that the Smiths original $70,000 mortgage has an interest rate of 6%. Assume the new $95,000 “purchase money” mortgage has a rate of 8%. The Smith’s “equity spread” is $25,000 ($95,000-$70,000) and they will earn 8% on that portion. But, the Smiths also are earning the difference between 8% the Buyer pays on the full amount and 6% they have to pay on the $70,000 underlying loan that remains in place. So, the Smith’s total return is a full 8% on the $25,000 and 2% on the 70,000 that they still owe. In fact that 2% return is huge because it is really not their money, they still owe it on the first mortgage.

Question: How would you like to earn 2% on someone else’s money?

Answer: All day long!

So, through this strategy, you’ve taken the existing mortgage’s lower interest rate(6%) and leveraged it into a higher yield (8%) for yourself. In addition, you can deduct all interest paid on a yearly basis as well as the real estate tax. Of course, as a shrewd investor, you can also use wrap around mortgages to turn around properties quickly at a profit.

There will be more details in future posts that outlines the advantages and disadvantages for each strategy. Subscribe to our feeds for regular updates, free gifts and a menu of resources.

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