Thursday, April 29, 2010
Friday, August 15, 2008
wrap around mortgages
"What is a wrap-around mortgage, and who is it good for?"
A wrap-around mortgage is a loan transaction in which the lender assumes responsibility for an existing mortgage. For example, S, who has a $70,000 mortgage on his home, sells his home to B for $100,000. B pays $5,000 down and borrows $95,000 on a new mortgage. This mortgage "wraps around" the existing $70,000 mortgage because the new lender will make the payments on the old mortgage.
A wrap-around is attractive to lenders because they can leverage a lower interest rate on the existing mortgage into a higher yield for themselves. For example, suppose the $70,000 mortgage in the example has a rate of 6% and the new mortgage for $95,000 has a rate of 8%. The lender’s cash outlay is $25,000 on which he earns 8%, but in addition he earns the difference between 8% and 6% on $70,000. His total return on the $25,000 is about 13.5%. To do as well with a second mortgage, he would have to charge 13.5%. I have a spreadsheet on my web site that calculates the yield on a wrap-around.
Usually, but not always, the lender is the seller. A wrap-around is one type of seller-financing. The alternative type of home-seller financing is a second mortgage. Using the alternative, B obtains a first mortgage from an institution for, say, $70,000, and a second mortgage from S for the additional $25,000 that B needs. The major difference between the two approaches is that with second mortgage financing, the old mortgage is repaid, whereas with a wrap-around it isn’t.
In general, only assumable loans are wrappable. Assumable loans are those on which existing borrowers can transfer their obligations to qualified house purchasers. Today, only FHA and VA loans are assumable without the permission of the lender. Other fixed-rate loans carry "due on sale" clauses, which require that the mortgage be repaid in full if the property is sold. Due-on-sale prohibits a home purchaser from assuming a seller’s existing mortgage without the lender’s permission. If permission is given, it will always be at the current market rate.
Wrapping can be used to circumvent restrictions on assuming old loans, but I don’t recommend using it for this purpose. The home seller who does this violates his contract with the lender, which he may or may not get away with. In some states, escrow companies are required by law to inform a lender whose loan is being wrapped. If a wrap-around deal on a non-assumable loan does close and the lender discovers it afterwards, watch out! The lender will either call the loan, or demand an immediate increase in interest rate and probably a healthy assumption fee.
When market interest rates begin to rise, interest in wrapping assumable loans will also rise. The incentive to sellers is powerful, since not only do they acquire a high-yielding investment, but they can often sell their house for a better price. But the high return carries a high risk.
When S in my example sold his house with a wrap-around, he converted his equity from his house, which he no longer owns, to a mortgage loan. Previously, his equity was a $100,000 house less a $70,000 mortgage. Now, his equity consists of the $5,000 down payment plus a $95,000 mortgage that he owns less the $70,000 mortgage that he owes.
The new owner has only $5,000 of equity in the property. If a small decline in market values erases that equity, the owner has no financial incentive to maintain the property. If the buyer defaults on his mortgage, S will be obliged to foreclose and sell the property to pay off his own mortgage.
In some seller-provided wrap-arounds, the payment by the buyer goes not to the seller but to a third party for transmission to the original lender. This is an extremely risky arrangement for the seller, who remains liable for the original loan. He doesn’t know if the payment on the old mortgage was made or not -- until he receives notice from the lender that it wasn’t. I recently heard from a seller who did such a wrap-around in 1996, and has been getting the run-around ever since. Payments by the buyer have often been late, and the seller’s credit has deteriorated as a result.
Or it can work out well, perhaps 9 of 10 deals do. The problem is that unless you know the buyer, you can never be sure that yours is not the 10th that doesn’t. The home seller who does a wrap-around can’t diversify his risk.
Copyright Jack Guttentag 2003
A wrap-around mortgage is a loan transaction in which the lender assumes responsibility for an existing mortgage. For example, S, who has a $70,000 mortgage on his home, sells his home to B for $100,000. B pays $5,000 down and borrows $95,000 on a new mortgage. This mortgage "wraps around" the existing $70,000 mortgage because the new lender will make the payments on the old mortgage.
A wrap-around is attractive to lenders because they can leverage a lower interest rate on the existing mortgage into a higher yield for themselves. For example, suppose the $70,000 mortgage in the example has a rate of 6% and the new mortgage for $95,000 has a rate of 8%. The lender’s cash outlay is $25,000 on which he earns 8%, but in addition he earns the difference between 8% and 6% on $70,000. His total return on the $25,000 is about 13.5%. To do as well with a second mortgage, he would have to charge 13.5%. I have a spreadsheet on my web site that calculates the yield on a wrap-around.
Usually, but not always, the lender is the seller. A wrap-around is one type of seller-financing. The alternative type of home-seller financing is a second mortgage. Using the alternative, B obtains a first mortgage from an institution for, say, $70,000, and a second mortgage from S for the additional $25,000 that B needs. The major difference between the two approaches is that with second mortgage financing, the old mortgage is repaid, whereas with a wrap-around it isn’t.
In general, only assumable loans are wrappable. Assumable loans are those on which existing borrowers can transfer their obligations to qualified house purchasers. Today, only FHA and VA loans are assumable without the permission of the lender. Other fixed-rate loans carry "due on sale" clauses, which require that the mortgage be repaid in full if the property is sold. Due-on-sale prohibits a home purchaser from assuming a seller’s existing mortgage without the lender’s permission. If permission is given, it will always be at the current market rate.
Wrapping can be used to circumvent restrictions on assuming old loans, but I don’t recommend using it for this purpose. The home seller who does this violates his contract with the lender, which he may or may not get away with. In some states, escrow companies are required by law to inform a lender whose loan is being wrapped. If a wrap-around deal on a non-assumable loan does close and the lender discovers it afterwards, watch out! The lender will either call the loan, or demand an immediate increase in interest rate and probably a healthy assumption fee.
When market interest rates begin to rise, interest in wrapping assumable loans will also rise. The incentive to sellers is powerful, since not only do they acquire a high-yielding investment, but they can often sell their house for a better price. But the high return carries a high risk.
When S in my example sold his house with a wrap-around, he converted his equity from his house, which he no longer owns, to a mortgage loan. Previously, his equity was a $100,000 house less a $70,000 mortgage. Now, his equity consists of the $5,000 down payment plus a $95,000 mortgage that he owns less the $70,000 mortgage that he owes.
The new owner has only $5,000 of equity in the property. If a small decline in market values erases that equity, the owner has no financial incentive to maintain the property. If the buyer defaults on his mortgage, S will be obliged to foreclose and sell the property to pay off his own mortgage.
In some seller-provided wrap-arounds, the payment by the buyer goes not to the seller but to a third party for transmission to the original lender. This is an extremely risky arrangement for the seller, who remains liable for the original loan. He doesn’t know if the payment on the old mortgage was made or not -- until he receives notice from the lender that it wasn’t. I recently heard from a seller who did such a wrap-around in 1996, and has been getting the run-around ever since. Payments by the buyer have often been late, and the seller’s credit has deteriorated as a result.
Or it can work out well, perhaps 9 of 10 deals do. The problem is that unless you know the buyer, you can never be sure that yours is not the 10th that doesn’t. The home seller who does a wrap-around can’t diversify his risk.
Copyright Jack Guttentag 2003
Difference between NOD, NOT and REO
What is the difference between NOD - NOT and REO?
There are many opprotunities today for the informed buyer. The key is making sure you stay informed and understand the processes.NOD- Notice of Default.This is the first official stage in the foreclosure process. The lender has a right to file the NOD at the very first late payment. In reality it’s usually 2~4 late payments before it’s done. The NOD is a recorded notice that the loan is “in default” but it’s not too late to simply pay the amount due and all is well. The delinquent amount will usually include late fees.IMPORTANT: this is only the amount owed to that particular lender. The owner may not have been making payments to the lender that holds the 2nd mortgage (or 3rd) and may even have taxes or other liens overdue that are attached to the property.Most NODs are cured (paid) before they advance to the next step (NOT). This is one reason that the news reports of huge increases in “foreclosures” are nonsense. The news reports include NODs as a part of their foreclosure statistics. A homeowner may have their property go NOD multiple timed before finally getting back on track, and never go NOD again. The news reports should specify what they mean by “foreclosure”. If nothing is done to pay the lender then it’s usually about 125 days from NOD to Auction at the courthouse steps.NOT- Notice of Trustee’s saleThis is when the clock really starts ticking. The NOT is a recorded notice that a trustee’s sale has been scheduled. If all late payments, fees, and penalties are not satisfied (paid) the property will be auctioned off on the “courthouse steps” to the highest all-cash bidder. The minimum amount is usually whatever the lender needs to pay off the 1st loan and other fees. This could mean that the 2nd lender may get absolutely nothing! There is incentive now for the 2nd lender to step up and buy the property at auction to protect their own interests.The “winning” bid, if there are any bids, gets the property as-is, including all liens (recorded or not). Here is where you need to have made sure BEFORE you made that bid exactly what liens are out there. If you need this type of information, contact me, I will point you in the right direction. REO- Real Estate Owned by the LenderMany properties do not sell on the “court house steps” at auction. When this happens, the property deed is transferred to the lender. This is when it becomes an REO. In most cases, lenders will hire the services of a Realtor to list the property for sale on the MLS. Depending on the lender, the list price is typically a price that will cause the property to sell in 30 days, or a “30 day price”. The good news for a buyer is that the property is purchased with normal legal and title protections and free of liens. Recent REOs I have seen are priced more competitively than in the recent past. Most banks are motivated to sell these properties and reduce the amount of inventory they have on their books. So, how do you decide which to make an offer on? Here are some of my own opinions:NODsIf you make a low offer, (at the very lowest side of retail values), but with good financing in place, there are many opportunities available to you in this arena. Many of these purchases will be short-sales. That adds complexity to the deal but also adds incentive for a seller to take a low offer. If they have no equity to protect then they really care more about avoiding foreclosure.There will be lots of competition here. The NOD is public record. Act quickly to be the first offer they see. There will be professional “flippers” out there looking to wrap mortgages, and competing heavily for these properties.Short-sales are very hard to complete in the time constraints imposed by the foreclosure process (about 125 days from NOD), and the banks are overloaded with NODs and they are under staffed in the departments that handle these types of sales.NOTs I don’t recommend NOT properties, unless you are very experienced in purchasing NOTs. You will need to have an understanding or Trustee Sale Guarantees and of Foreclosure Guarantees, and have a working relationship with a title officer at your local title company. If you have cash on hand, make sure to spend some of it at the title company first, there are some great deals possible. Offer a low price and close quickly.REO Basically these are treated the same as any other MLS listing. It’s a little more difficult to hammer-out a deal with a distant lender but not too bad. In fact recently banks have started to reject short-sales and instead are selling the properties after the auction as REOs. The banks seem more open to looking at offers now that they have many more properties to sell. If you know values in the neighborhood of the home, you may ignore the asking price and offer a fair market price.I believe the best deals right now are in the REO properties. However, you must know the market, and be prepared to make an offer. You will have to follow the bank’s procedures in addition to the normal sale contracts and documents. The bank is also not going to give useful disclosures, and is not typically willing to do any repairs, so inspections by experts become critical. Pre-REO An Owner that is currently not in default, but will be soon, is a very motivated seller wanting to sell quickly. Unfortunately, many who bought 1~2 years ago will not be able to sell at current prices without bringing some money to the closing table. Unfortunately, these are very painful deals and the seller is usually forced into a short-sale deal with the lender.Remember that all types of “foreclosure” properties are having an effect on our traditional market today. It has always been wise to take time to discuss with me the many homes on the MLS as well as the “distressed” foreclosure homes. Good deals are out there now the Buyer who know what they want and is financially prepared to move. The deals do not need to be foreclosures to be good deals! About Me
There are many opprotunities today for the informed buyer. The key is making sure you stay informed and understand the processes.NOD- Notice of Default.This is the first official stage in the foreclosure process. The lender has a right to file the NOD at the very first late payment. In reality it’s usually 2~4 late payments before it’s done. The NOD is a recorded notice that the loan is “in default” but it’s not too late to simply pay the amount due and all is well. The delinquent amount will usually include late fees.IMPORTANT: this is only the amount owed to that particular lender. The owner may not have been making payments to the lender that holds the 2nd mortgage (or 3rd) and may even have taxes or other liens overdue that are attached to the property.Most NODs are cured (paid) before they advance to the next step (NOT). This is one reason that the news reports of huge increases in “foreclosures” are nonsense. The news reports include NODs as a part of their foreclosure statistics. A homeowner may have their property go NOD multiple timed before finally getting back on track, and never go NOD again. The news reports should specify what they mean by “foreclosure”. If nothing is done to pay the lender then it’s usually about 125 days from NOD to Auction at the courthouse steps.NOT- Notice of Trustee’s saleThis is when the clock really starts ticking. The NOT is a recorded notice that a trustee’s sale has been scheduled. If all late payments, fees, and penalties are not satisfied (paid) the property will be auctioned off on the “courthouse steps” to the highest all-cash bidder. The minimum amount is usually whatever the lender needs to pay off the 1st loan and other fees. This could mean that the 2nd lender may get absolutely nothing! There is incentive now for the 2nd lender to step up and buy the property at auction to protect their own interests.The “winning” bid, if there are any bids, gets the property as-is, including all liens (recorded or not). Here is where you need to have made sure BEFORE you made that bid exactly what liens are out there. If you need this type of information, contact me, I will point you in the right direction. REO- Real Estate Owned by the LenderMany properties do not sell on the “court house steps” at auction. When this happens, the property deed is transferred to the lender. This is when it becomes an REO. In most cases, lenders will hire the services of a Realtor to list the property for sale on the MLS. Depending on the lender, the list price is typically a price that will cause the property to sell in 30 days, or a “30 day price”. The good news for a buyer is that the property is purchased with normal legal and title protections and free of liens. Recent REOs I have seen are priced more competitively than in the recent past. Most banks are motivated to sell these properties and reduce the amount of inventory they have on their books. So, how do you decide which to make an offer on? Here are some of my own opinions:NODsIf you make a low offer, (at the very lowest side of retail values), but with good financing in place, there are many opportunities available to you in this arena. Many of these purchases will be short-sales. That adds complexity to the deal but also adds incentive for a seller to take a low offer. If they have no equity to protect then they really care more about avoiding foreclosure.There will be lots of competition here. The NOD is public record. Act quickly to be the first offer they see. There will be professional “flippers” out there looking to wrap mortgages, and competing heavily for these properties.Short-sales are very hard to complete in the time constraints imposed by the foreclosure process (about 125 days from NOD), and the banks are overloaded with NODs and they are under staffed in the departments that handle these types of sales.NOTs I don’t recommend NOT properties, unless you are very experienced in purchasing NOTs. You will need to have an understanding or Trustee Sale Guarantees and of Foreclosure Guarantees, and have a working relationship with a title officer at your local title company. If you have cash on hand, make sure to spend some of it at the title company first, there are some great deals possible. Offer a low price and close quickly.REO Basically these are treated the same as any other MLS listing. It’s a little more difficult to hammer-out a deal with a distant lender but not too bad. In fact recently banks have started to reject short-sales and instead are selling the properties after the auction as REOs. The banks seem more open to looking at offers now that they have many more properties to sell. If you know values in the neighborhood of the home, you may ignore the asking price and offer a fair market price.I believe the best deals right now are in the REO properties. However, you must know the market, and be prepared to make an offer. You will have to follow the bank’s procedures in addition to the normal sale contracts and documents. The bank is also not going to give useful disclosures, and is not typically willing to do any repairs, so inspections by experts become critical. Pre-REO An Owner that is currently not in default, but will be soon, is a very motivated seller wanting to sell quickly. Unfortunately, many who bought 1~2 years ago will not be able to sell at current prices without bringing some money to the closing table. Unfortunately, these are very painful deals and the seller is usually forced into a short-sale deal with the lender.Remember that all types of “foreclosure” properties are having an effect on our traditional market today. It has always been wise to take time to discuss with me the many homes on the MLS as well as the “distressed” foreclosure homes. Good deals are out there now the Buyer who know what they want and is financially prepared to move. The deals do not need to be foreclosures to be good deals! About Me
Wednesday, August 13, 2008
question on home value
Q: so the value of my home can drop if the homes for sale in my neighborhood drop their price for quick sale? my home is under 3 yrs old in a new subdivision
A: Yes. The value of your house is based on the value of other nearby comparable houses. That's the way Realtors perform a CMA (competitive market analysis). That's the way appraisers judge the value of a house. And--most important--that's the way prospective buyers make purchasing decisions. If your house was worth, say, $300,000, but two nearby similar properties are for sale for $275,000, then that's what your house is worth...approximately. And, unfortunately, some of the biggest drops in some areas (for instance, in Northern Virginia there's a real nice area called Ashburn) have been for recently-constructed homes. That's, in part, because of the run-up in prices in 2003-2005. If someone bought a house in, say, 2000, maybe their house "on paper" went up, then dropped, so it's perhaps slightly above the purchase price in 2000. But if you bought at the top of the market in, say, 2005, values didn't go up much more before they started coming down. So someone who bought in 2000 may have had a "paper loss" if he/she sells. But someone who bought in 2005 could have an actual, out of pocket, loss. Prices will recover, but it'll take time. So if you bought your house in 2005 and its value has dropped--maybe to below what you paid for it--you've now got a "paper loss." In a while--maybe 3 years, maybe 5 years--values will rise enough so that you're not facing a drop in price from when you bought. Hope that helps.
A: Yes. The value of your house is based on the value of other nearby comparable houses. That's the way Realtors perform a CMA (competitive market analysis). That's the way appraisers judge the value of a house. And--most important--that's the way prospective buyers make purchasing decisions. If your house was worth, say, $300,000, but two nearby similar properties are for sale for $275,000, then that's what your house is worth...approximately. And, unfortunately, some of the biggest drops in some areas (for instance, in Northern Virginia there's a real nice area called Ashburn) have been for recently-constructed homes. That's, in part, because of the run-up in prices in 2003-2005. If someone bought a house in, say, 2000, maybe their house "on paper" went up, then dropped, so it's perhaps slightly above the purchase price in 2000. But if you bought at the top of the market in, say, 2005, values didn't go up much more before they started coming down. So someone who bought in 2000 may have had a "paper loss" if he/she sells. But someone who bought in 2005 could have an actual, out of pocket, loss. Prices will recover, but it'll take time. So if you bought your house in 2005 and its value has dropped--maybe to below what you paid for it--you've now got a "paper loss." In a while--maybe 3 years, maybe 5 years--values will rise enough so that you're not facing a drop in price from when you bought. Hope that helps.
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