This collection of six videos covers notes and IRAs and wraparound financing. It is for note investors who want to see how wraps work and how they relate to IRAs.
It starts with a recorded live session on IRAs and notes, then moves on to wraparound notes, with two worked examples.
After the videos, a written guide explains how a wraparound works, with a simple numeric example, and the main points to check before holding notes in a retirement account.
Live session: IRAs and notes
A recorded live session on IRAs and notes.
Wraparounds and IRAs
This video looks at wraparound notes and IRAs.
Top 10 reasons to use wraps
This video goes through ten reasons to use wraparound financing.
A simple wrap example
This video walks through a simple wraparound example.
The wrap note and deed of trust
This video covers the wrap note and the deed of trust.
The North State wrap example
This video walks through the North State wrap example.
What a wraparound note is
A wraparound, or wrap, is a form of seller financing used when the seller still has a loan on the property. Instead of paying that loan off at closing, the seller leaves it in place and carries a new, larger note for the buyer. The new note “wraps around” the old one.
Each month the buyer pays the seller on the wrap note, and the seller keeps paying the underlying loan. The seller earns the difference between the two payments. Depending on the state, the wrap is secured by a mortgage or a deed of trust, just like any other real estate note.
Worked example: the spread on a simple wrap
Here is an illustrative example with round numbers. A seller has a $100,000 loan balance at 5% with 25 years left. He sells the property for $200,000 with $20,000 down and carries a $180,000 wrap note at 7% over 30 years.
| Balance | Rate | Monthly payment | |
|---|---|---|---|
| Wrap note (buyer pays seller) | $180,000 | 7% | $1,197.54 |
| Underlying loan (seller pays lender) | $100,000 | 5% | $584.59 |
| Seller’s monthly spread | $612.95 |
The seller earns interest on his $80,000 of equity in the note, and also earns the gap between 7% and 5% on the $100,000 he still owes. That rate difference is the main reason investors use wraps. You can test your own figures with the note calculator.
Risks to understand before using a wrap
- Due-on-sale clauses. Many mortgages let the lender demand full payment if the property is sold. Have an attorney review the underlying loan before you structure a wrap.
- The underlying loan must stay current. If the seller stops paying the lender, the buyer can lose the property even though the buyer paid on time. Many wraps use a third-party servicer to collect the buyer’s payment and pay the underlying loan.
- More parties, more paperwork. The wrap note and security instrument need to describe the underlying loan clearly.
- Local rules. Seller financing and wrap rules vary by state and province and change over time.
Holding notes in a self-directed IRA
A self-directed retirement account can, in many cases, hold real estate notes. The account, not you personally, owns the note, and payments go back into the account. That can make notes a way to put retirement money to work in real estate without owning property.
The rules are strict, though. There are limits on who your account can do business with, including you and certain family members, and breaking them can have serious tax consequences. Contribution limits, account types and tax treatment also change over time and differ between the US and Canada. Work with your account custodian and a qualified tax professional before you buy a note in a retirement account.
For a closer look, see investing in real estate notes with your IRA and self-directed IRA mistakes.
