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WRAPAROUND RICHES By David A. Chodack Have you ever wanted to have your own business with a steady income coming in month after month, rain or shine, regardless of the condition of the economy? This is why people buy rental properties. But, owning and managing rental property is a lot of work and a lot of risk. How would you like to quickly build a sell that property instead and have an income for life, with no responsibilities? This is what the "wraparound", otherwise known as the all-inclusive, or over-riding loan can do for you if you understand how to use it. MAKING MONEY ON OTHER PEOPLE'S MONEY A wraparound loan takes an existing first loan - preferably with a relatively low outstanding balance and interest rate - and wraps a new, seller-carried loan with a larger balance - and ideally a higher interest rate -- around it. This way, the Seller is collecting payments on the new, larger loan and making payments on the old, smaller loan and pocketing the difference as income. For example, let's say you are selling a property for $100,000 and you have an assumable existing loan of $60,000 at 7% interest and $40,000 in equity. The "normal" way to sell the property would be either to ask the Buyer to put down 10% or 20% in cash and get a new loan for the balance, or to let the Buyer assume that $60,000 loan and then come up with the balance in cash. This way, the Seller walks away with $40,000 in cash. Or, the Buyer could come up with part of the balance in cash, say $20,000 and the Seller could carry a second loan for the other $20,000. Either way, the Seller walks away with a lump sum of money - and has to pay taxes on any profit - but gets no on-going income. THE SELLER BECOMES A BANKER With a wraparound loan, the Seller offers the Buyer a new loan of anywhere from $60,000 to $100,000 at 8% interest.. This has several advantages for both the Seller and the Buyer . The Seller gets a steady income without having to keep the property as a rental and put up with all the hassles that entails. The Seller also gets to make money on someone else's money. He is paying 7% interest on the existing loan and collecting 8% interest on the loan he is carrying for the Buyer. This means that the Seller is making anywhere from $600 to $1,000 a year just on that 1% difference. If that Seller gets a Buyer with poor credit or low income who can't qualify to get a new loan and/or assume an existing loan, then he/she might be able to get as much as 12% interest or more and make up to $3,000 a year or more, just on the interest rate spread. FULL DISCLOSURE AND ASSUMABILITY ARE ESSENTIAL Now, you must inform the Buyer that this is what you are doing. You can't just let the Buyer think that the property is free and clear, with no underlying encumbrances and that that you are just carrying a loan for the amount of your own equity. This is Fraud. You must clearly inform the Buyer that the note you are going to carry will be secured by an Over-riding or All-inclusive Trust Deed (or Mortgage) and that there is an underlying loan for which you will remain responsible. The wraparound loan also leaves you with a lot of liability and responsibility. That underlying loan remains in your name and you remain responsible for the payments, even if the Buyer defaults on his/her payments to you. Therefore, you have to be prepared to keep making those payments and to take back the property in a foreclosure if the Buyer ever does default. And, if the Buyer does make his/her payments to you, but you don't keep up the payments on that underlying loan, then again, this Fraud and you could go to jail. BENEFITS FOR THE BUYER AND THE SELLER But, the Buyer also benefits with a wraparound loan if everything is done right and everyone fulfills their responsibilities. He/she avoids loan fees and points as well as the need to qualify for a loan through a lender, and this is why he/she should be willing to pay a slightly higher interest rate, but unfortunately, you can only use a wraparound when the existing loan is assumable. Most new conventional loans issued nowadays have alienation clauses. These say that as soon as the property is sold, the loan is due and payable. In full. Therefore, you can't keep the old loan and carry a new one for the Buyer. However, there are plenty of private and government insured loans around which are fully assumable and so the Wraparound loan can be a very effective tool to use, particularly when interest rates are historically low and bound to go up in the future. ********************************************************************************************************************************* EQUITY SHARING : SAVIOR OR SCAM? By David Chodack Before you decide whether Equity Sharing is right for you, you have to forget all the hype, all the propaganda you've heard for and against Equity Sharing and ask yourself if there is a reason why you need a partner and what a partner (or partners) can and will do for you. Then make a logical decision. SCAMMERS OVER-HYPE A GOOD THING Unfortunately, Equity Sharing has received a lot of bad publicity, thanks to scam artists and fast buck seminar promoters who tried to pass it off as a brilliant new concept that they had invented that would revolutionize Creative Real Estate investing. In order to sell books, tapes and seminars, they made all sorts of fantastic claims, most of which were nothing but Urban Myths. "Eliminate Negative Cash Flow!" they promised property owners and would-be investors. "Rid yourself of management problems forever!" To would-be Buyers, they promised an easy way to buy property with no money down, instead of renting. In fact, at least two different seminar speakers told eager listeners that they could live in luxury homes for free, simply by finding two wealthy doctors (or lawyers or other wealthy people) who wanted tax write-offs and letting them equity share the property and split the mortgage payments and taxes between them. Unfortunately, many people got themselves into trouble by following this type of advice. They bought properties knowing that they couldn't break even on the rents, but convinced that Equity Sharing would solve all their negative cash flow problems and that prospective Equity Share Buyers would be beating down their doors, anxious to pay any premium over and above the normal rental rates for the area just for the chance to own a piece of the property in the future. Or, they bought luxury properties and then waited in vain for those two rich doctors to come along anxious to pay the mortgage for them while they lived rent free. Some of them are still waiting, or were before they went into foreclosure. Many other people though, have used some form of Equity Sharing successfully, because they went into it with open eyes and realistic expectations. Even banks and other institutional lenders have used Equity Sharing by going into partnership with builders and developers and taking equity in their projects in exchange for favorable financing. They knew what they wanted Equity Sharing to do for them and so they structured the contract accordingly. It's all in the contract and the way you write it. FACTORING IN ALL THE VARIABLES There are several variables which must be taken into account in order to structure a successful Equity Sharing agreement. First of all, you have to decide how much Equity you want to share and under what terms and conditions. The "typical" Equity Share agreement -- at least as it is usually presented in seminars and books and tapes - means that the Buyer makes the payments, including taxes and insurance for a period of five years and then the Buyer and Seller split the equity equally at the end of that time period. WHAT IS "EQUITY"? The problem comes in defining what "Equity" is. Is it the difference between the price the property will eventually sell for and the amount of loans against it? Or is it the difference between the value of the property at the time the Equity Share contract is signed and the eventual sales price, minus expenses? Is the Buyer entitled to share in any existing Equity at the time the Equity Share agreement is signed? For example, you have a property you want to Buy or Sell for $100,000. It has a $40,000 loan against it and $60,000 Equity. You come to an Equity Share agreement which says that the Buyer will occupy the property for five years and pay all expenses and then it will be sold and the profits after expenses will be divided. What does this really mean? Five years later, you sell the property for $150,000, with $10,000 in expenses. By then, the loan has been paid down to $35,000, so the difference after expenses, is $105,000. How much does the Buyer get? Half? Or only half of the $40,000 difference between $100,000 -- the agreed upon value at the time the Equity Share agreement was signed -- and the $140,000 net sales price after expenses? IT DOESN'T HAVE TO BE 50/50 Why does the Buyer necessarily have to get half the profits? Why can't the figure be 25%? Or 75%? Or even 100% of the profits? When does the Buyer actually go on title? At the time the Equity Share agreement is signed? At the end of the five year Equity Share period? What if the Buyer defaults and doesn't keep up the payments during the five year Equity Share period? Does the Equity Share period have to be five years? Why not one year? Why not ten years? EVERYTHING IS NEGOTIABLE It's all negotiable. That's what writing creative contracts is all about. If you are the Buyer, then you want to get control of the property and go on title as quickly as possible so you can begin getting tax benefits. You also want a piece of everything over and above that $40,000 loan. You also want to protect yourself and make sure that you really will get your fair share of the property when it is sold - especially if you are paying more than the market rent for the property during the Equity Share period. If you are the Seller, then you want to wait as long as possible before putting the Buyer on title. You also want to share as little of the profits as possible and you want to make sure that you are protected in case the Buyer does default on his/her responsibilities? But what if the property is not sold at the end of the Equity Sharing period? What if the Buyer or the Seller decides they want to hold on to the property? Or, what if it doesn't sell as planned? These variables all have to be accounted for in the contract, In order to avoid nasty surprises and/or disagreements, later on. Of course, all this assumes that the Equity Share agreement is between a Buyer and a Seller. However, this is not always the case. What if the Equity Share agreement is between a prospective homeowner who wants to get into a property with little or no money down and an investor who wants to own a rental property without having to hassle with tenants? This creates a whole new set of possibilities and variables. Covering all these bases is what Contract Wizard is all about. IGNORANCE IS COSTLY If you think $97 for a program that can produce an ideal contract is expensive, then try putting together deals without it ……….. COMMON QUESTIONS BEGINNING INVESTORS ASK Q: How can I get my deposit back if I decide not to buy a piece of property? A: Legally, a Seller has to prove that he lost money if he wants to keep the deposit. But possession is nine tenths of the law, so always make sure that a neutral party, like a title or escrow company holds the money. Never give it to the Seller or his representative. ********************************************************************************************************************************* Q: My broker said I could save at least half a percent interest with a five year loan. Should I go with this, or get a 30 year loan? A: It depends on how long you intend to stay in the property. If you stay more than five years, it's probably not worth it, because refinancing is expensive. If you're there less than five years, why pay the bank any more than necessary? ********************************************************************************************************************************* Q: What are closing costs and who pays them? A: Closing costs are all the extras and incidentals associated with buying and selling property, including escrow and title fees, loan fees and "Discount Points" the percentage of the loan amount the lender deducts in advance as an additional fee. They average anywhere from 1.5% to 3% of the loan amount, or more and except in the case of certain government insured loans, they are negotiable. ********************************************************************************************************************************* Q: If I sign a Lease-Option agreement, does at least part of my rent apply to my down payment when I buy the property? A: Only if you specify that in the Lease-Option agreement. It's completely negotiable. Lease-options can be structured to favor either the tenant/buyer, or the landlord/seller. It is up to you to structure the lease-option in a way that will benefit you THE WIZARD'S WISDOM "Have all your goals and objectives mapped out before you write (or accept) a Purchase Contract "Think from the other person's point of view "Don't just ask for what you want. Spell out how you expect to get it. "Structure Win-Win deals. Try to get what you want and give the other person what they want. "Be creative. Be patient. There are many ways to make deals work. Search for the best way for You, the way which will give You the most benefits. "Some times you have to trade Price for Terms, or Terms for Price. When you can't have both, decide which is most important. HOME PAGE |