Let's Talk About Wraps

I’m not talking about those things you eat when you’re trying to be healthy or avoid yeast. I’m talking about a financial tool that many people have either never heard of or have avoided because they’ve heard they’re evil and/or illegal. Some years ago that may have been true and could have very easily gotten people in a lot of trouble with their mortgage company causing them to be suddenly homeless.
This isn’t the case these days as long as you play by the rules and have people do things the right way for you. In short form here’s what a wrap is and how they work:
A wrap is an “Agreement for Sale” where the buyer agrees to complete the agreement by re-financing the property by or on a given date (typically five, seven or ten years from the date of the agreement) for the balance of the existing note at which time the buyer is given title to the property. During the agreement period the buyer has “Equity Title” to the property meaning as the property value increases during that period that value transfers to the buyer upon completion of the agreement. As an example, a property is currently worth $150,000.00 but the current owners owe $200,000.00 so an agreement is drawn up that the sellers will sell the property to the buyers for $200,000.00 with the agreement to be completed five years from the date of the agreement. At the end of that period the appraised value of the property is now $225,000.00. Once the deal is complete the buyer gets clear title to the property and $25,000 in equity right from the beginning.
What are the advantages to doing something like this? Well… if you’re a seller it would keep you from going upside down on your property causing you to walk away from it and have your credit ruined. It would also give you some positive cash flow during the agreement period. The monthly payment is based on the $200,000.00 figure so after the current mortgage payment and taxes are paid each month the difference goes to the current owner. If there was down payment money over and above all of the costs of the transaction then they have that to look forward to as well.
If you’re a buyer it means you don’t have to qualify for a loan right away giving you a chance to clean up your credit so you can qualify when the time comes. There are also tons of people like waitresses, bartenders, entertainers, sales people (and even realtors) who work on commission or a cash basis that make it difficult to qualify for a home loan. Let’s face it…most everyone has been affected by the dismal economy we’ve had to endure the past few years to one degree or another. For many people this may be the only way they can purchase a home again for many years to come. Like anything else though it’s not entirely simple and something everyone can do. It would require a buyer to come in with more cash than they might if they were trying to purchase a home these days. Typically you would come in with roughly 5% down for financing under “normal” circumstances. With a wrap that could increase 10-15% or more. A large amount of that would go to covering your transaction costs and possibly any back payments, but many sellers expect (and deserve) to see some cash in their pockets to cover their own expenses (like moving) right away.
Are there down sides to all of this? Yes, on both sides. For the sellers there’s the risk the buyers would default on the agreement. The buyers could also damage the property.
The upside to that is that it’s an agreement not a lease and no deed has been recorded yet. They can be evicted much quicker and cheaper that you can a renter (usually 30-45 days) plus you still have the house and can re-sell it again, plus you have had your mortgage paid during that time frame and picked up a little extra cash as well. A servicing company will always be mandated to receive the payment from the buyer and distribute the funds to the current mortgage, taxes, insurance and any leftover funds to the seller. This protects both buyer and seller so that no disputes arise as to whether a payment was made or not and also eliminates funds not making it to the proper places at the right time. Also the sellers would have to continue to make the homeowners insurance during the agreement period which (as noted above) would be paid through the existing mortgage servicing company.
For the buyers they need to make sure that when the time comes they can qualify for a new loan. Since it’s an agreement and they only have equity title on the house they can’t borrow money against it for any reason. They can make all of the home improvements they want to the property… just out of their own pocket. A new pool would have to wait until after the agreement is completed. Any major improvements (like an extra room) would require approval from the current owner and possibly the HOA (if there is one). Since the buyers don’t legally own the home yet they would have to have “Content Insurance” (renters insurance) to cover their personal belongings from fire and theft which is something they’d have to plan for.
If the current note is an FHA loan there are quite a few more forms that will need to be signed with the agreement but it can be done, it just takes a little longer. VA and Conventional notes are a little easier on the paperwork but all three aren’t opposed to doing wraps and neither are most lenders these days. In fact some lenders welcome them rather than have to deal with a short sale or foreclosure.
Are wraps right for everyone and/or every situation? Absolutely not, but they are right for more people than anyone might think. The best way to find out is to talk to someone like me and let us work through your personal situation. If we can’t go down that route we may be able to come up with an alternative situation.