What issues should you consider with “wraparound” financing?
Wrap-around financing usually means that there is an assumable loan on the property, say $30,000 at 6 percent, and that a seller or other party takes back a loan for the buyer, say, $100,000 at 7 percent. The $100,000 consists of the continued obligation to repay the old $30,000 debt and $70,000 in new debt. The seller or lender effectively receives 2 percent interest on the first $30,000 and 8 percent on the remaining $70,000. Since the seller or lender did not provide the first $30,000, the rate of return for the $70,000 they did provide is substantially higher than 8 percent.
Some questions to ask include:
- Is the first trust assumable? If no, can the lender use a due-on-sale clause to call the loan?
- Who has title to the property?
- What happens if the seller/lender has title and does not make a payment on the first trust?
- What can the buyer/borrower deduct if title remains in the name of the seller?
- What happens if the seller/lender has title and does not pay tax payments?
- What happens if the seller/lender has title and the place burns down? Who gets the insurance money?
- Are there local rent control regulations? If yes and the buyer/resident does not have title, is this individual a renter under local rent control rules?
- If there is a fire at the property, who is paid by the insurance company?
Etc.
Because wrap-around financing raises a number of complex issues, both buyers and sellers should individually consult with attorneys and tax professionals prior to accepting such arrangements.
© Copyright 