Option 1: The Investor can offer to hold a standard «second mortgage» in the amount of $371, at an agreed upon rate close to market rates for second mortgage loans (perhaps, 10.5%), amortized over an agreed upon period (say, 20 years with a 15 year balloon) and buyer can assume or take subject to the existing first Mortgage bearing interest at 6.25%. In this case, the Buyer would get the benefit of the lower interest rate on the first Mortgage, while paying a 10.5% market rate of interest on the second mortgage; or
Option 2: the Investor might offer the Buyer a «wrap-around mortgage» for the entire amount being financed ($1,650,000) at a below market interest rate for a first mortgage loan with interest of, say, 9% on the entire amount, amortized over 20 years with a 15 year balloon.
If Option 1 is chosen, the Investor will receive at closing the sum of $550,000 in cash, and will «hold paper» for $371, secured by a second mortgage, earning 10.5% interest per year, generating a monthly payment of $3,, and a final balloon payment of $172, in 15 years. 5%.
If Option 2 is chosen, the Investor will receive at closing the sum of $550,000 in cash, and will «hold paper» for $1,650,000 bearing interest of 9% (desirable to Buyer because it is .5% less than market, and results in a monthly payment of only $14,, an amount $ per month less than payday loans IN available at the hypothetical current market rate of 9.5%). Of the $1,650,000 held by Investor, only $371, represents funds actually «loaned» by Investor .
There is no legal reason a Bank or other lender could not be the wrap-around Mortgagee under similar circumstances provided it is not prohibited by regulatory mandate or internal loan policies from securing loans through use of a «junior mortgage»
At first glance, it may seem that these funds will earn interest at only 9% instead of 10.5% available under Option 1, but consider further: Through use of a wrap-around mortgage, the Investor would also earn a 2.75% return on funds of the original lender because of the spread between the 6.25% interest rate on the first mortgage loan and the 9% interest rate on the wrap-around mortgage loan.
As a consequence, the monthly payment received on the wrap-around mortgage would be $14,. After payment of the underlying monthly payment of $10, due on the existing first mortgage, the net amount retained from the wrap around mortgage payment during the life of the underlying first mortgage is $3,, (in this case, $ per month more than the monthly payment receivable under Option 1, above, with only a second mortgage position. More significantly, at the end of 15 years, when the underlying first mortgage has been fully amortized and paid off, the balloon payment receivable under the wrap-around mortgage proposed in Option 2 would be $715, ($542, greater than in Option 1 – and, in fact, nearly double the amount originally loaned, due to accumulated interest from negative amortization), generating an effective overall yield on Investors actual cash investment of $371, at a rate of % per annum compounded monthly during the life of the loan.
Since the mortgage «wraps around» the original first mortgage loan, the balance of the wrap-around mortgage amount, $1,278,, represents funds actually advanced by (remaining unpaid to) the original first mortgage lender
Under Option 2, both the Investor and the Buyer benefit, and the original lender continues to receive the rate of return originally contracted for under the first mortgage.
In the foregoing examples, we have assumed that it is the Investor/»Seller» who is providing the financing and who will be the «wrap-around Mortgagee». This is not necessarily the case.