Zted, Wraparound mortgages legal, but carry high risk

Wraparound mortgages legal, but carry high risk
May 31, 2009|Benny L. Kass

Q: I have a full-price offer on my duplex that involves a wraparound mortgage. I am a little leery of a small down payment with high interest payments for a few years and a balloon payment at the buyer's refinance later.

I'm told they are quite legal, but I really need to know the pros and cons. Can you enlighten me please?

A: Here's how a wraparound mortgage works. Let's say that you sell your house for $500,000, and have an existing mortgage (deed of trust) on the property for $300,000. Title is transferred to your buyer, who pays you $10,000 in cash, and you take back a mortgage in the amount of $490,000. This is a second mortgage, because your existing mortgage is not paid off at the closing (escrow).

Your first mortgage carries an interest rate of 6 percent and the new second trust will be paid at 8 percent. Each month, your buyer sends you a check based on the 8 percent interest rate, and you send your current lender the regular monthly payment you have always made.

There is a monetary advantage to you. You receive a 2 percent differential on your existing $300,000 (because your buyer is paying you 8 percent) and you also receive the full 8 percent on the remaining $190,000 ($490,000 minus $300,000).

But there is also a disadvantage. Your buyer has put up only $10,000 and can easily decide to walk away from the deal, leaving you stuck with your existing mortgage and having to foreclose on the property.

Additionally, because your buyer is taking title "subject to" the existing mortgage, you (and your buyer) run the risk that the lender could exercise the "due on sale" clause and call the entire mortgage due and payable.

We used these wraparounds in the early 1980s, when interest rates were very high and buyers wanted to take advantage of the existing lower rates that were already on the property.

Yes, the transaction is legal, but there are too many risks. Unless your buyer puts up a lot of money - say 20 or 25 percent of the purchase price - I cannot recommend that you pursue this further.