Creative Real Estate Financing: Lease Purchase, Lease Option, Subject To, Wrap-Around Mortgage

Lease Purchase

Since the real estate market in the United States has collapsed, many people have looked to alternative means in order to sell properties and potentially avoid foreclosure.  This has lead to many people using contract structures like a lease purchase or lease option.

Subject-To

Other structures to sell properties in non-conventional manners have also become popular.  Two examples are assumptions and ‘subject to” deals.  The problem is that most conventional mortgages contain acceleration clauses that allow the original lender to call in the entire amount due early if the property is transferred to a third party without its consent. In reality, as long as the regular mortgage payments are made on time and in full and sent in the name of the original buyer, “Subject To” agreements are never discovered by the original lender so there is no problem; nevertheless, the threat of the debt being called in overhangs most “Subject To” contracts.

Wrap-Around Mortgage

The Wrap-Around Mortgage is a compromise between these two methods of passing on an outstanding mortgage to a new buyer. In such an arrangement, the seller (the person that owns the property and is liable for the outstanding mortgage on it) accepts a secured promissory note from the new buyer for the balance due on the property’s original mortgage plus whatever profit the seller is receiving and in exchange extends a secondary mortgage to the new buyer. Since the entire arrangement is formalized, it amounts to a method of seller-financing that allows the seller full landlord rights over the property, including the right of foreclosure should the new buyer default on the secondary mortgage. The new buyer sends his monthly payments to the seller, who in turn sends the appropriate amount to the original lender that holds the primary mortgage on the property.

Wrap-Around mortgage agreements can allow the seller to find a buyer that might not qualify for original financing from the original lender, thereby expanding the pool of potential buyers. Further, if a Wrap-Around Mortgage is used in conjunction with a lease purchase agreement or an option, it can circumvent the threat of the original lender exercising the primary mortgage’s acceleration clause to call in the debt early. For the buyer, the primary advantage is that they get a much stronger right of residency and possession of the property than they have with a “Subject To” contract, while at the same time avoiding the qualification requirements of the original lender (the financial institution holding the primary mortgage).

The only real risk to such agreements is to the new buyer as there have been cases of the seller not sending in payments to the original lender. The result of such a situation is that the original lender forecloses, resulting in the new buyer being evicted while the seller disappears. Therefore new buyers should be prudent when exploring the possibility of entering into a Wrap-Around Mortgage Agreement with a seller and should check into the seller’s background and financial position. Any legitimate seller should be forthcoming about their financial position, so if the seller is reluctant to provide background information, the buyer should consider this a strong warning of potential problems.

Also if you’re not already familiar, it’s always good to keep your knowledge fresh about 1031 exchange rules and the 40 year mortgage.

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