During the course of your involvement with seller-financed mortgages and trust deeds, you will eventually run into what is known as a wrap mortgage. What is this thing? Is it something you give as a gift, a hip new type of note (no pun intended), or a mortgage that has come to the end of its term, like when you hear “That’s a wrap” at the end of a project?
Common sense tells you it’s none of the above. So what is it?
A mortgage inside another mortgage
In simple terms, a wrap is one mortgage inside of another mortgage. Picture a Tootsie Pop. (Think back: how long does it take you to get to the center of a Tootsie Pop?)
The candy coating is the last mortgage put on the property, and it wraps entirely around the Tootsie Roll center, which is any lien that already exists on the property. The whole thing is one lollipop, just as all the liens together are one wrap mortgage, but there are different parts to the whole.
How a seller ends up creating a wrap
Usually when someone sells their property, the cash from the sale is enough to pay off any existing debts the seller owes on it. These debts can include mortgages, tax liens, judgments and any other amounts that could cloud the title.
That’s what we picture when we think of a sale, but it isn’t always what happens. Sometimes the seller does not pay off all the liens secured by the property and instead creates a wrap mortgage.
The seller takes back a mortgage for the sales price minus the down payment. This mortgage is wrapped around the mortgages or liens the seller still owes on the property. In our experience, we have only seen mortgages wrapped around mortgages, but it is conceivable that the underlying amount (the part in the middle) could be some other type of lien. Sounds confusing? It isn’t as bad as you may think.
Following the numbers in a wrap sale
Here is how a sale looks using a wrap mortgage. The selling price is $100,000. The buyer puts down $25,000 in cash, and the seller takes back a mortgage for $75,000.
Inside that $75,000 sits $20,000: the amount the seller still owes on the property after the sale. We call it the underlying mortgage. It is part of the $75,000, not an amount added to it.
| Item | Amount |
|---|---|
| Selling price | $100,000 |
| Buyer’s down payment | $25,000 |
| Wrap mortgage taken back by the seller | $75,000 |
| Underlying mortgage inside the wrap | $20,000 |
Why didn’t the seller pay off the $20,000? Maybe he owed a first of $18,000 and a second of $20,000. He used the $25,000 down payment to pay off the first (the second then moved into first position) and kept the rest for other expenses. Maybe he owed too much in other fees and liens to pay off everything. Or maybe he simply needed the $25,000 for other things.
A sophisticated seller may also want to earn money on the spread: the difference between the interest rate he charges on the wrap and the rate he pays on the underlying mortgage. This only works when the underlying rate is lower, for example a $75,000 wrap at 9.5% around a $20,000 underlying at 7.5%.
Why a wrap is not a first and a second
A first and a second mortgage are separate layers. A wrap is one mortgage made of different parts.
On paper, the wrap looks like the only mortgage on the property. In reality there is a first mortgage, the underlying lien left in place ($20,000 in our example), and in effect a second for the difference between the wrap and the underlying ($75,000 − $20,000 = $55,000).
If the wrap paid off tomorrow at $75,000, the seller would keep only $55,000. The rest would go to pay off the underlying lien. In a foreclosure, the underlying lien would also get paid before the rest of the wrap.
What to ask before you quote a wrap
When you search the courthouse for note holders, you will see wrap mortgages and all-inclusive trust deeds (AITDs) recorded alongside ordinary mortgages and trust deeds. When you see one of these documents, you immediately know what you are dealing with.
Besides the usual information you need to give a quote, find out how much the note seller still owes on the underlying mortgage. Many note buyers want the underlying paid off from the note seller’s proceeds. They don’t want to collect a payment from the payor and then send out a payment on the underlying.
Suppose the wrap is for $60,000 and the note seller still owes $55,000 on the underlying. Chances are the note seller would not get enough cash to pay off the underlying. Your note holder doesn’t really have a $60,000 mortgage. He is owed $5,000, because the other $55,000 is owed to someone else.
In general, we find that if the underlying is more than 50% of the wrap balance, there is usually not enough cash or incentive to satisfy a note seller.
Where land contracts are the norm, get in the habit of asking whether there are any underlying mortgages. In about 50% of the cases we see, there is an underlying mortgage or another land contract. And it gets very confusing when one land contract is wrapped around another land contract, wrapped around yet another land contract or mortgage.
The concept of a wrap mortgage is not a difficult one. You just have to unwrap the wrap so you know what you are buying.
Ricki Eskenazi is a founder of SES Funding Corp., a national note investment firm.
