Wrap- around contract explained

Question: What is a wrap-around contract?

We are looking at buying a home for sale by the owner, and they are offering to sell to us with such a contract.

J.M., Duvall

Answer: Frankly, I would not advise doing a private contract in today’s market because even though mortgage rates have risen from their 2004 lows, they are still very affordable. The only reasons you might want to consider doing a private contract now would be if you cannot qualify for a conventional mortgage or the sellers are offering you a below-market interest rate.

Now, to answer your question:

As the term implies, a wrap-around contract is a type of financing where the seller carries back a private note that wraps around the existing mortgage on the home.

For example, let’s say I’m selling a house for $300,000 and I owe $150,000 on the existing mortgage. I’m willing to take a $30,000 down payment with the balance of the purchase price to be financed on a $270,000 private contract using a wrap-around note. Here’s how it would work:

Let’s assume the payment on my $150,000 mortgage is $850 per month. I would carry back a $270,000 note at an interest rate of 7 percent with payments of $1,796 per month, based on a 30-year amortization schedule. That means I would collect $1,796 from the buyer each month, make the $850 payment on my existing loan, and then pocket the $946 difference. The existing mortgage would stay in place and my private note would wrap around it.

Note that the interest rate on the wrap-around note is slightly higher than the going rate for a conventional loan. That’s because a private note carries more risk. Buyers looking for seller-financing often have poor credit, income that is unpredictable or difficult to document or both. That’s why they can’t get a loan from a bank. If I’m going take more risk than the bank, I deserve to be paid a higher interest rate for my trouble.

Just keep in mind that the interest rate charged on a wrap-around note, or any private contract, is subject to negotiation between the buyer and seller. In some cases, the seller might want to offer below-market rate financing. Why? Maybe the seller is retiring and they just want an ongoing income stream rather a lump sum of cash. By offering a below-market rate, there is less chance you will pay off the loan early.

Also notice that the payments on the wrap-around note are based on a 30-year amortization schedule in order to keep the monthly payments low. In the real world, sellers are rarely willing to carry a private contract for 30 years, so there is typically a balloon payment clause in the note. For example, the remaining balance on the note might be due and payable in full on the fifth anniversary of the note.

That’s called a five-year balloon note. As the seller, if my goal is to be cashed out as soon as possible, I would make the balloon period short (e.g., three years). But if I’m carrying the note as a means of generating extra retirement income, I would make the balloon period long (e.g., 10 years), or I might not have any balloon payment clause at all. I might instead have a 30-year note with a due-on-sale clause that would require the buyer to pay me off if and when the house is sold in the future.

That’s because I’m carrying the contract based on the creditworthiness of the person buying my home. I don’t want to let the buyers have some stranger assume the loan and take over the payments because I have no way to know whether the new buyers are creditworthy.

That brings up the problem of the due-on-sale clause on the existing mortgage on the home. Placing a wrap-around loan on a home will trigger the due-on-sale clause on the current mortgage – but only if the lender finds out about it.

The reality is that many buyers take title to a home subject to the existing mortgage on the property. The payments continue to be made each month, either by the seller or the new owner of the home. As long as the lender receives the proper payment each month, nothing happens.

However, if the lender finds out that the property has changed hands – usually in a notification from the insurance company of new name on the homeowner’s policy – the entire remaining balance of the loan can be called due and payable.

That’s a risk the buyer and seller take whenever there is a private note wrapped around a conventional loan containing a due-on-sale clause. I’m not making a value judgment here, just stating the facts.

Sellers using a wrap-around note, or any kind of private financing, should also include a prepayment penalty clause in the note if their goal is long-term income. One of the tricks used by unscrupulous real estate investors is to convince a seller to settle for a low price based on a private contract with a very high interest rate. The investor emphasizes how much money the seller will earn over the life of the loan in exchange for taking a lower sales price today.

Unfortunately, many of these sellers see their expected income stream dry up when the investor quickly turns around and refinances the property at market rates and cashes out the seller.

To prevent this from happening, the note should include a stiff prepayment penalty that makes it very expensive for the buyer to pay off the loan during the first few years.

But as I said at the beginning, if you are a home buyer and you can qualify for a conventional mortgage, I would not mess around with a private contract. Go to your local bank or mortgage company and get a loan.

Mail your real estate questions to Steve Tytler, The Herald, P.O. Box 930, Everett, WA 98206. Fax questions to Tytler at 425-339-3435 or e-mail him at economy@heraldnet.com.

Talk to us

More in Herald Business Journal

FILE - In this Monday, March 23, 2020, file photo, a worker walks near a mural of a Boeing 777 airplane at the company's manufacturing facility in Everett, Wash., north of Seattle. Beginning in 2024, some 737 planes will be built in Everett, the company announced to workers on Monday. (AP Photo/Ted S. Warren, File)
With 747 out, Boeing to open new 737 Max line at Everett’s Paine Field

Since the last 747 rolled out of the factory, speculation has been rife that Boeing might move some 737 Max production to Everett.

IonQ will open a new quantum computing manufacturing and research center at 3755 Monte Villa Parkway in Bothell. (Photo courtesy of IonQ)
Quantum computing firm IonQ to open Bothell R&D center

IonQ says quantum computing systems are key to addressing climate change, energy and transportation.

Nathanael Engen, founder of Black Forest Mushrooms, sits in the lobby of Think Tank Cowork with his 9-year-old dog, Bruce Wayne, on Friday, Jan. 27, 2023, in downtown Everett, Washington. (Ryan Berry / The Herald)
Growing green mushrooms in downtown Everett

The founder of Black Forest Mushrooms plans to grow gourmet mushrooms locally, reducing their carbon footprint.

Barb Lamoureux, 78, poses for a photo at her office at 1904 Wetmore Ave in Everett, Washington on Monday, Jan. 23, 2023. Lamoureux, who founded Lamoureux Real Estate in 2004, is retiring after 33 years. (Annie Barker / The Herald)
Barb Lamoureux, ‘North Everett’s Real Estate Agent’ retires

A longtime supporter of Housing Hope, Lamoureux helped launch the Windermere Foundation Golf Tournament.

AGC Biologics in Bothell to produce new diabetes treatment

The contract drug manufacturer paired with drug developer Provention Bio to bring the new therapy to market.

FILE - In this file photo dated Monday, March 11, 2019, rescuers work at the scene of an Ethiopian Airlines plane crash south of Addis Ababa, Ethiopia.  The number of deaths in major air crashes around the globe fell by more than half in 2019 according to a report released Wednesday Jan. 1, 2020, by the aviation consultancy To70, revealing the worst crash for the year was an Ethiopian Airlines Boeing 737 MAX on March 10 that lost 157 lives. (AP Photo/Mulugeta Ayene, FILE)
US board says Boeing Max likely hit a bird before 2019 crash

U.S. accident investigators disagree with Ethiopian authorities over the cause of a 2019 Boeing 737 Max crash.

Store owner Jay Behar, 50, left, and store manager Dan Boston, 60, right, work to help unload a truck of recliners at Behar's Furniture on Monday, Jan. 16, 2023. Behar's Furniture on Broadway in Everett is closing up shop after 60 years in business. The family-owned furniture store opened in 1963, when mid-century model styles were all the rage. Second-generation owner, Jay Behar says it's time to move on. (Annie Barker / The Herald)
Behar’s Furniture in Everett closing after 60 years

“It’s time to move on.” The small family-owned store opened in 1963 and grew to cover an entire city block.

Katy Woods, a Licensed Coach, Branch Manager, and experienced Banker at Coastal Community Bank.
Coastal Community Bank Offers Classes for Businesses

To support local business owners and their teams, Coastal offers complimentary Money… Continue reading

Innovative Salon Products online fulfillment employees, from left, Stephanie Wallem, Bethany Fulcher, Isela Ramirez and Gretchen House, work to get orders put together on Friday, Jan. 6, 2023, at the company’s facility in Monroe, Washington. The company began including pay, benefits and perks to its job listings over a year ago, well ahead of the new statewide mandate to include a pay range on job postings at companies with over 15 employees. (Ryan Berry / The Herald)
New state law requires employers to give pay range in job postings

Washington’s new pay transparency law aims to narrow wage gaps based on race or gender — though some companies may seek loopholes.

Paddywack co-owner Shane Somerville with the 24-hour pet food pantry built by a local Girl Scout troop outside of her store on Tuesday, Dec. 20, 2022 in Mill Creek, Washington. (Olivia Vanni / The Herald)
An out-paw-ring of support: Mill Creek pantry feeds pets, day or night

With help from local Girl Scouts, the Mill Creek pet food store Paddywack is meeting the need for pet supplies in a pinch.

Kelly Cameron is the woodworker behind Clinton-based business Turnco Wood Goods. (David Welton)
Whidbey woodworkers turn local lumber into art

In the “Slab Room” at Madrona Supply Co., customers can find hunks of wood native to the south end of Whidbey Island.

Siblings Barbara Reed and Eric Minnig, who, co-own their parent’s old business Ken’s Camera along with their brother Bryan, stand outside the Evergreen Way location Thursday, Dec. 15, 2022, in Everett, Washington. After five decades in business, Ken’s will be closing its last two locations for good at the end of the year. (Ryan Berry / The Herald)
Print it or lose it: Ken’s Camera closes after decades caught on film

The local legend, processing film photos since 1971, will close its locations in Mount Vernon and Everett at the end of 2022.