Owner Financing Myth Buster:How to Sell a Property by Wrapping the Existing Mortgage

[Jay Koch]

I have been spending a lot of time reading blogs about owner financing of real estate transactions, and there seems to be myth out there that you can not do owner financing if the property is not free and clear. I’m here to bust that myth.

One common way to sell a property with an existing mortgage is the process of “wrapping†the mortgage. That is, the seller carries a note that is at least as large as the mortgage, and then uses the proceeds of the incoming payments to make his mortgage payment.

For example, let’s suppose the price of the house is $100,000, and the existing mortgage is $60,000. The payments on this mortgage are $500 per month. Billy Buyer tells Sam Seller that he only has $20,000 to put down. In addition, Billy has some bruised credit and my have a hard time qualifying for a regular mortgage. Sam is retiring and moving to a smaller place. If he received $20,000 from the transaction he would be OK.

Sam says to Billy, “Pay me the $20,000 down payment, and give me a note for $80,000 payable at $700 per month.†Sam will take the $700 payment, use it to make his mortgage payment and pocket $200 per month. Billy does not have to qualify for a mortgage, closing costs are lower, and he can move in a couple of weeks instead of a couple of months.

The $80,000 note wraps the $60,000 mortgage. The proceeds of the bigger note are used to pay the smaller debt.

That’s the big, simple concept. Of course, there are a lot more details to it than that, and that is a topic for another article. But there is one big thing to watch out for.

The mortgage company usually has the right to call the mortgage all due and payable on sale of the property.

This means that several months or years after the sale, if the mortgage company finds out that Billy has moved into the property it will ask Sam to pony up the entire $60,000 he owes. The mortgage company can’t ask Billy to pay up, since it lent the money to Sam. But if it forecloses on the house, Billy is out of a home and out all money he paid Sam.

Sounds scary, doesn’t it? It can be, but here’s the truth: it rarely happens. In today’s market, the mortgage company would rather have a performing mortgage, even if Sam is not living in the property, than an empty foreclosed house. I worked for a company that services thousands of wrapped contracts, and there was only one mortgage called due in the last fifteen years because of a wrap.

Now, if interest rates go back up, and the mortgage companies are in a stronger market, this may change. If interest rates go to 8%, 9%, 10%, or higher, Sam’s mortgage company is going to become more active in finding wrapped mortgages. They will not want to hang onto Sam’s lower interest rate loan, and will ask that it be re-financed.

So, wrapping a mortgage is relatively safe for now, but it may not always be so. The due on sale clause is the source of the myth that it is not possible to sell a property using seller financing with an existing mortgage. It is possible. It is not uncommon. It is not illegal. But there is some risk to it. You need to assess that risk.

As usual, check with your attorney and real estate broker before making any commitments. I strongly recommend that you do not do any real estate transactions with the counsel of professionals. I am neither an attorney nor a broker, so I can’t advise you.