Sub2 + Wrap = Good Idea?

[David Weiss]

I have a question for investors who are experienced in both "Subject To" and "Wraparound Mortgage" deals.

I have a guy who wants to mentor me in the following investing strategy:

- Put a house under contract for a 90 day option to purchase subject to.

- Find a buyer interested in an owner-financed deal.

- Purchase the house Sub2.

- Sell the house via a wrap.

Mr. Potential Mentor says that because you're offering owner financing you can typically boost the sale price 10% and the interest 2% (assuming the original owner had an average flat rate) and collect 10% down, creating an early payday plus pretty good passive income.

If you can't find a buyer within your option period you walk away, making the risks comparable to wholesaling. It's the buyer's house so there are no landlord headaches. If the buyer defaults you can foreclose, rehab and resell or return title to the original owner, with reselling being preferable both ethically and financially (carry the costs and sell the house twice, doubling the DP's and extending the passive).

There are obviously several legal considerations, but the potential mentor's partner is an experienced and highly regarded RE attorney so I feel comfortable there.

Lastly, the potential mentor doesn't want any payment up front. His compensation will come in the form of profit-sharing.

It sounds like a pretty sweet deal....

My question to those of you who are experienced with these forms of creative financing is this:

Assuming I can avoid buying bad properties and assuming the lawyer competently covers the legal bases, are there any risks to this strategy not captured above? Or does this mentor and his strategy seem like a pretty good deal for a newbie investor?

Thanks so much for your time, insights and advice.

[Jon Holdman]

Originally posted by David Weiss:

Jon, could you please provide some detail around the risk associated with rising interest rates? Since the bank has no relationship with the new owner/occupant, I am not understanding how exactly the bank could force the o/o to refinance. And if they can, what would that do to the wrap?

They can't directly do any thing with the wrap. They can, however, call the original loan, the one you bought the property subject to. If they call the note, it will have to be paid off. If it can't be paid off, they will foreclose and they will take then house. That means your buyer will lose the house even if they are making all their payments.

Even though you're the one that bought it subject to, you cannot refinance - you don't own the house! Now, if you have cash, or can get cash, you could pay off the original lender. Then you could continue to hold the wrap note. But if you cannot then it will be up to the end buyer to refinance. That would allow them to pay off the wrap note to you and then you would use that money to pay off the underling loan.

The interest rate risk comes if rates pop up. The risk will depend on the rate on the underlying loan. If its at todays 3-4% rates, the risk is higher than if its at, say, 6% or 7%. Back when I first started looking at buying a house, about 1983-4, OO rates were, hold on to your hat, 15%. Even when we finally bought a house in 1987 we paid 9% on a owner carried 15 year note and thought we had a great rate. If rates jump up toward 9%, rest assured that banks will try to figure out how to get 3% loans off their books. Calling the notes on properties sold subject to is an easy and totally legal way to do that.