What is a Subject-To Wrap?
The deed to the property and the mortgage are two different documents, and as such, a distressed seller is able to actually sell the deed to the property and keep the existing mortgage in place. This selling strategy is known as a subject-to purchase. This strategy benefits a homeowner as they may sell a home subject-to and not have to come out of pocket on any Realtor commissions or closing costs. In many cases, selling a home subject-to may be the difference between the sale occurring or the home going to auction.
Purchasing a property subject-to the existing financing remaining in place benefits the investor because they can take over a property without using their own credit, without having to qualify for a new loan, and for lower holding costs than with a hard money loan. This strategy allows an investor to purchase multiple distressed properties without the involvement of a bank.
Once the investor purchases a property subject-to, a popular way of selling it involves creating a new note with the end buyer and wrapping this new note around the old one.
Subject-to Wrap Benefits
When selling a house with a wrap around mortgage, the new note wraps around the original mortgage to create a new mortgage. The new mortgage is paid for by the new buyer and the investor pays the original mortgage. The new note that is created is subordinate to the underlying financing and can be created on any terms that are agreed to by all parties.
Wrap notes are typically written with balloon dates in a few years to encourage the new tenant/buyers to obtain their own credit once the credit repair expert they are paired with works with them to fix the dings on their FICO report.
The benefits of the subject-to wrap for the investor are as follows:
1) As the investor, the subject-to wrap allows you to receive money when you sell the property initially in the form of the down payment / owner finance fee, monthly cash flow and when you cash in on your equity (the difference between the sellers note and your new note) when the mortgage balloons at the end of your term.
2) As the investor, the subject-to wrap allows you receive a better cash flow than as a landlord. First, charging a higher than market average interest rate will generally bring you in higher monthly revenue than what the rental market would pay. Second, because you are the bank, you are also not responsible for property taxes & insurance, thus decreasing your monthly expenses. More revenue minus less expenses is another reason that owner financing is popular.
3) As the investor, your job is to go to the mailbox once a month collect checks. You are not a landlord; you are the bank and as such, NOT responsible for repairs.
3) As the investor who plays the role of the bank, you can determine whether or not a buyer qualifies instead of leaving it up to banks and underwriters and other players in which you have no control. If their credit score, job history, and reserve requirements are to your liking, then you make the decision as to whether or not to execute the deal. And you can make this decision quickly!
Subject-to Wrap Detriments
Anytime you are selling a property with the subject-to wrap, you are technically violating the banks ‘due on sales‘ clause, which gives the bank the right to call a note due when there is a transfer of ownership. With the subject-to wrap strategy, you are generally holding onto the property for 3-7 years, increasing the chances that the note may be called due. However, banks are typically unmotivated to call a performing note due and make the asset non-performing. While there are very few examples of the banks calling notes due in this type of scenario, it is still a threat and something the investor must disclose to the other parties.
In conclusion, the subject-to wrap strategy is very popular. First, this strategy can help a distressed seller with no equity in their house sell and otherwise unsellable house to an unloanable buyer who otherwise wouldn’t qualify under today’s tough lending requirements. These types of transactions are good at preventing homes from going into foreclosure and good for the economy by letting profitable real estate transactions occur. When performing a subject-to wrap transaction, it is highly recommended you seek council from a real estate attorney and disclose all risks to both parties.