One of my favorite creative finance techniques to buy investment real estate is the wraparound mortgage (WRAP).

A wrap is exactly what it sounds like – it’s a mortgage that wraps around an existing mortgage. In a wrap, the seller leaves the existing mortgage in place, sells the property to the buyer and gives the buyer a mortgage on the property that is subordinated to the existing mortgage. 

If it sounds complicated it’s because it is complicated – especially of things go wrong. 

Let me give you an example of a wrap to make it easier to understand. 

The seller’s property is worth $250,000 and has a mortgage with Countrywide for $200,000 at 6% interest. The seller then sells the property to you for $220,000 and gives you a mortgage for $220,000 at 7% interest. The mortgage that the seller gives you is subordinated to the first mortgage held by Countrywide and is recorded as a second mortgage on the property.

• The seller is still responsible to pay Countrywide the monthly payments on the first mortgage of $200,000 at 6%.
• You are responsible to pay the Seller a monthly payment on the second mortgage of $220,000 at 7%.
• This means that you will pay the seller more than the seller pays Countrywide because your mortgage is larger ($220,000) and at a higher interest rate (7%).

The deal is still a good deal for you because you got the property at a discount plus didn’t need to get and pay for a conventional mortgage. There’s no credit process, no loan application, no appraisal and no little or closing costs. Most importantly, the loan doesn’t appear on your credit report as the seller ill not report your repayment history to a credit bureau. 

This allows you to purchase more investment real estate and is an excellent creative finance technique. 

The deal is good for the seller because the seller has sold the property, created a monthly income stream and a future profit of $20,000 when you resell the house. When you resell the property you will be forced to pay off the first mortgage and the wrap second mortgage in order to pass clear title to the new buyer.

A wrap mortgage also gives the seller more protection than a simple subject to sale as it records the legal instrument (the mortgage) that the seller can use to recover title in the event of default by the buyer. 

One important point to consider is that because a wrap mortgage involves the transfer of title to the buyer, the first mortgage holder may have a due on sale clause in its loan agreement with the seller. This means that the lender can accelerate the loan and call the entire loan due and payable. This rarely happens as long as the first mortgage is paid on time but it is a risk. The seller also needs to be careful to update the hazard insurance policy for the property and change all utility and property tax records. 

It’s also important to note that if the buyer defaults on the note, it will be necessary for the seller to foreclose in order to regain title to the property. This is more time consuming and costly than a simple eviction. 

So why would any seller consider a wrap mortgage? 

In a down market it may not be possible for the seller to sell the property with conventional financing. The property may not appraise for the amount of the outstanding mortgage, the house may need fix up work to make it loan compliant or it may simply not attract a qualified buyer. 

In a down economy there is no shortage of unqualified buyers, starting with investors. It’s very difficult to get a non-owner occupied loan following the credit meltdown. This means that investors, with good credit scores and solid financials, can’t get finance or can only get with high interest rates and a large down payment.   

If the seller is willing to offer a wrap mortgage this will entice investors to buy the property.

About Ross Hair

Ross Hair is the Real Estate Advocate and founder of eRealEstate.com, a social network for real estate investors and real estate professionals.

 A great source of creative finance is owner finance or seller carry back. 

This is particularly true if the seller has equity in the property. Owner finance or seller carry back occurs when the seller agrees to provide you with a loan to help you purchase the property.

 You can get a loan for the full amount of the purchase price or a portion of the purchase price.

Usually you will need to get a new loan for most of the purchase price and then the seller will carry back a loan secured by a second mortgage or deed of trust. The new loan will pay off the seller’s existing mortgage and the owner finance covers the balance of the purchase price. 

It is surprisingly easy to get the seller to carry back some of the loan. The main reason is that the carry back loan usually represents profit to the seller gained by the increase in value to the home. It’s not money out the seller’s pocket.

Let’s use a practical example. 

The seller purchased his property her property for $120,000 in 1986. The original mortgage was for $96,000 and the current outstanding balance is $72,000. The property is now worth $198,000. 

In this type of example you could offer the seller $120,000 in cash or a new mortgage and then have the seller carry the balance of $78,000 as a second mortgage. 

The benefit to the seller is that the property is sold and the original mortgage loan is paid off. That’s no small matter in a down economy. The second mortgage also represents an annuity investment for the seller as the seller will get a monthly interest payment on the loan. 

The disadvantage to the seller is that she doesn’t immediately get all her money out of the deal and if the new buyer defaults on the loan the seller may be forced to foreclose on the property. This is expensive and time consuming and will result in the seller getting the house back. 

This technique works equally well in a bad market. It just looks a little different. 

In a case where the seller is unable to sell his property because it’s a slow market the seller can provide owner finance. Buyers who can not get a mortgage loan today will pay a premium for an owner finance house. If the buyer can’t get any loan then the seller can provide owner finance through a technique called a wraparound mortgage (wrap).

Ross Hair is the Real Estate Advocate and founder of eRealEstate.com, a social network for real estate investors and professionals.

The easiest way to use creative finance is to get a real estate loan from a hard money lender.

There is a simple rule in real estate that if you find a great deal then finding the money is easy. The reason for this is that hard money lenders will fund 100% of your deal if it is a great deal.

A hard money lender is usually a private lender who lends based on the value of the asset pledged as security as opposed to the creditworthiness of the buyer. Think of a hard money lender as an asset backed lender.

This means you can have no cash, no credit and no experience and still get a loan if the deal is a good deal. The question then becomes what is a good deal?

Hard money lenders will generally lend up to a maximum amount of 75% of the fair market value of the property. 75% of the fair market value may be more than 100% of the purchase price of the house.

As an example, if you find a house worth $200,000 and you can buy it for $130,000, the hard money lender will lend you 75% of $200,000. That’s $150,000 which is more than 100% of your purchase price.

The hard money lender may also give you the cost to fix up the house if the Loan to Value stays under 75% of the After Repair Value (ARV). Let’s say that you needed $20,000 to fix up the house and that the after repair value of the house would be $200,000. In those circumstances most hard money lenders would give you the $130,000 you need to purchase the house plus the $20,000 you needed to fix up the house. That’s a total of $150,000 with no money out of pocket by you.

I’ve noticed that hard money lenders have tightened up their lending criteria following the downturn in the real estate market. Most lenders will appraise the property lower than you expect and require some kind of down payment – even on the best deals. Just like regular bankers, hard money lenders like you to have some “skin in the game”.

Experienced investors rely on hard money and private lenders to finance most of their deals. It’s usually really easy to work with a hard money lender as the credit application process is much simpler. 

There is a significant cost to using hard money. The interest rates are usually high around 12% to 18% and you will normally be required to pay between 3 and 5 points on the amount of the loan. A point is equal to 1% of the loan amount so one point on a $150,000 loan is equal to $1,500. The cost is bearable in a short term project but is prohibitive in a long term hold. 

The one big drawback with hard money is that most loans are short term, usually between 6-months and a year. The reason for this is the lender wants his money back so he can lend it out again and get another 2 to 5 points. 

The short term and high cost makes hard money suited for short flip projects as you will need to either sell the property or refinance into more reasonable interest rates.

In the next article I’ll discuss owner finance or owner carry.

About Ross Hair

Ross Hair is the Real Estate Advocate and founder of eRealEstate.com, a social network for real estate investors and real estate professionals.

One thing I’ve learnt as a real estate investor  is that sometimes the best mortgage is  no mortgage at all. 

If this sounds cryptic, let me explain.

In many real estate deals you don’t need a loan or any real finance.

If you are wholesaling a property it is almost always to your financial advantage to not close on the deal but rather flip or wholesale it to another real estate investor.

The biggest problem with funding deals is that finance is very expensive. In particular the closing costs can make or break a deal. On average it costs $7,500 in closing costs to buy a property. This covers loan origination fees, title fees, lender escrows etc. That’s $7,500 worth of wasted costs if your intention is to flip the property. By the time you add holding costs and costs to resell the property you will have wasted at least $12,000.

You just gave away a nice chunk of your profit. 

Closing on a deal also creates a number of other problems.

The biggest problem is that banks hate it when you flip properties because it’s just bad business for them as they actually lose money on the loan. To stop you flipping a property banks have “seasoning” requirements. This means that they will not finance a new loan or refinance an existing loan unless the original loan is at least six or twelve months old. This is a huge problem for you because if your new buyer can’t get a loan your deal is probably dead. 

So what’s the solution? It’s simple really – don’t close on the deal.

There are a number of ways to avoid closing on a deal: 

i.          Assignment

The easiest way to flip a property without closing is to assign the contract. Effectively you are selling your rights in the contract to a new buyer. Take note that what you are selling is the contract, not the property. 

By law all agreements are assignable unless specifically excluded. However, note that most real estate contracts prepared by real estate brokers and real estate commissions have a clause that excludes assignment without written consent by the seller.

To make your contract assignable, simply add a clause that says, “This contract is assignable by the buyer” or contract in the name of “Your Name and or Assigns.” 

Assignment does have some problems. The main problems are that the seller and your buyer get to know each other before the deal closes. This creates an opportunity for them to cut you out, especially when the new buyer finds out how much you are making on the deal. 

The second problem is that the lender doesn’t like assignments and will often require you to write a completely new contract between the seller and your buyer. This increases the risk that you will be cut out of the deal. 

ii.         Be the Real Estate Broker

If you are serious about real estate investing I HIGHLY RECOMMEND that you get a real estate license. It is the single most important tool that you can use as a real estate investor. I know you will meet many investors who will tell you why they don’t have a real estate license but I promise you that they are wrong. I got a real estate license and it made me at least $250,000 a year by doing deals that would not have worked if I didn’t have a license. 

A real estate license allows you to structure deals so that you get your money out of the deal easily and at closing. Whenever I assign deals, I simply rewrite them to take my name out the buyer and put my name in as the real estate broker. My profit is reflected in the agreement as a commission. I get my money at closing with no hassles and no chance of being cut out of the deal. The best part is that the lender has no problem with the seller paying a commission to a broker, even if the commission is 10% of the purchase price.

On a $200,000 house that’s $20,000. Paid at closing, fully disclosed and signed off by the lender. It’s that simple.

Just try and push a $20,000 fee past a lender as a “third party pay off” or “marketing fee”.

And don’t forget that by making yourself the broker you avoid having to close on the deal in your own name. 

iii.        Double Close 

Sometimes it is not possible to assign or broker a deal and you will be forced to close. This usually happens when the seller is an institution like a lender with a REO or a HUD home. They simply don’t allow assignments. 

There is a creative way to close the deal but not incur the costs or problems associated with closing. It’s called the double close. 

A double close occurs when the seller sells you a property that you resell to a new buyer and the closing takes place at the same time. Effectively the new buyer gets a home loan and the proceeds of that loan are used to pay the seller. You don’t get a loan and consequently avoid all the costs of raising the loan. You also don’t hold title as title passes through you to the new buyer.

As you can guess it’s a pretty complicated process and needs the full support and co-operation of the title company. Most title companies won’t do double closes as it exposes them to too much risk. However there is an ”investor friendly” title company in every major city who has the expertise and experience to handle a double close. 

The sticky issue concerning a double close is the funding.

Some title companies don’t require that you bring any funds to the table as they will use the funds from the new buyer to fund the deal and pay the seller. This is called phantom funds as your funds don’t exist. 

Some title companies do require that you bring funds to the closing. Believe it or not, but there are hard money lenders who will provide this short term funding. It’s called flash funding and usually costs a couple of points. 

I’ve used flash funding for a number of deals. My hard money lender has accompanied me to the closing with a cashier check for my purchase price. The check never left my lender’s hand. He sat at the closing table with the check in his hand. Only after the resale of the property to the new buyer had funded and the title company had authority to disburse funds did he hand the check over to the title agent – who promptly handed the check back to him plus a check for $4,000, being the two points on a $200,000 loan.

 $4,000 for four seconds of funding! Good work if you can find it. 

The point of this story is that it was worth it for me to pay $4,000 in fees because it was the key to making the deal work …. and I got a check for $11,000 at the close

In the next article I’ll give you my first tip on using creative finance for your real estate deals.

About Ross Hair

Ross Hair is the Real Estate Advocate andPresident of eRealEstate.com, a social network for real estate investors and professionals.

Without exception, every successful real estate investor that I know has one thing in common – they all know where to find the money. They understand that money is the life blood of the real estate investment industry and they’ve all invested their time and resources to find reliable sources of finance for their deals. 

I firmly believe that the opportunity always lies in the obstacle.

In real estate investing the lack of money is a huge obstacle that most investors can not overcome. Very few investors ever find a solution to the “money” problem. This means that those savvy investors who do find a solution to the money problem face considerably less competition for deals and can cherry pick the best deals. 

Think about it a little differently – why is it that we’re taught to make “cash” offers and “close in one week” when trying to buy a property at a discount? It’s because sellers know that cash buyers have the means to actually buy and close on their property. Most sellers would rather accept a sure thing cash deal than a higher offer with financing contingencies. 

If you had all the cash you needed would you be a successful investor?

The great thing about buying real estate is that although you need money it doesn’t need to be your money. It’s called OPM – Other People’s Money. It’s a trillion dollar industry and its goal is to assist people to buy real estate. Companies like banks and lenders want to lend you money. All you need to do to get their money is understand their rules. 

The most undervalued part of investing in real estate in finding the right financing for your real estate investment deals. My philosophy is “follow the money” because once you have the money, doing deals is no problem. 

Most people associate real estate investing with going to a conventional lender, completing a loan application and getting a home loan. As an investor, unless you plan on holding long-term, conventional finance is one of the least attractive ways to fund your deals. 

There are many ways to finance a deal. You can get money from a conventional lender, a private lender, the seller, any third party, the property itself and even gift or grant programs.

Don’t limit yourself to traditional funding and don’t be afraid to be creative.

In my next post I’ll show you where to find the money.

About Ross Hair

Ross Hair is the Real Estate Advocate and President of eRealEstate, a social network for real estate investors and professionals.