aitd/wrap question - Posted by adam

Posted by adam on April 11, 2006 at 23:11:44:

well hopefully i will need the contracts soon! flow chart of how it works is what i am looking for, i think john hit the nail on the head here, but if you have anything else that would be great too!

aitd/wrap question - Posted by adam

Posted by adam on April 11, 2006 at 10:53:45:

hey guys, i did some searching and found a good definition but what i am looking for is a working example of an all inclusive trust deed/wrap note, aka substitution of collateral. i saw greg pinneo over the weekend and he was explainging this but im still confused. some generic examples would be great help! thanks guys!

Re: aitd/wrap question - Posted by John Behle

Posted by John Behle on April 11, 2006 at 20:52:01:

You may need to start all over right from the beginning. You said “aka substitution of collateral”. That is not correct. A wrap around loan has nothing whatsoever to do with a substitution of collateral.

A “wrap around” is both a concept and terminology relating to a type of transaction. It is NOT a particular form. The term wraparound describes the transaction where one loan wraps around an existing loan. This is usually seller financing, but not always. Institutions and lenders can do wraps.

A wrap is NOT an “All Inclusive Trust Deed” or AITD, but an AITD is a form of wrap around loan. By definition, an all inclusive trust deed “includes” or is inclusive of pre-existing loans. Otherwise, it would just be a trust deed.

A “wrap” is NOT a contract for deed (CFD), but a contract for deed MAY be a wrap. Usually a CFD does have underlying loans that it wraps, but a CFD can also be in a first position on a property.

Those are the two primary types of wraparound loans.

An AITD and CFD are different types of documents used in a “Wraparound” situation. Substitution of Collateral again has nothing do do with a wraparound.

If you have a $100,000 property that can be purchased with terms of $20,000 down and seller financing for the balance, here are some scenarios. Let’s say there is an existing first loan of $50,000. Whether it is assumable or with an individual or institution makes no difference as far as how a wrap is structured (except for some minor clauses that may be used).

EXAMPLE ONE - Assume first create new second.

Buyer gives 20k down, assumes the 50k first and creates a new second to the seller (seller financing) for the remaining balance of 30k. This approach is just a new second and not a wrap.

EXAMPLE TWO - 20k down and a contract for deed (wrap).

There are many good reasons for a wraparound loan. One can be to deal with a non-assumable loan. The seller may want to stay in the middle to make sure payments are made. Another reason can be to take advantage of good terms on existing loans like a low interest rate.

So, in this example, the buyer puts 20k down and creates a wrap in the form of a contract for deed for the remaining balance of 80k. That is the total of the existing 50k loan and the balance of the seller’s equity of 30k. Buyer makes payments to the seller or an escrow and then buyer or escrow agent makes payments on the existing 50k loan. Most of the time the existing lender is not involved in or may not even know about the sale of the property.

The difference between the amount owed to the seller of 80k and the amount they owe of 50k is the seller’s equity - referred to as the “equity in the wrap”.

What can be real nice about a wrap is that the return on the seller’s equity may be very high. Let’s say the rate on the 50k first loan is 7%, but the rate on the wrap is 9%. The seller not only gets 9% on his 30k, but he/she also picks up 2% on the bank’s 50k. If the terms of the loans were the same, the seller’s rate of return is roughly 12.3%. The true rate of return is calculated with a financial calculator taking into account the length of the loans and payments. I won’t go into that right here. It’s a two day seminar. The smaller the “Equity in the Wrap” and the greater the spread in the interest rates, the higher the yield or rate of return. You can end up with a very small amount invested for a large cash flow and rate of return exceeding 20-30%. When I started into real estate, I created wraps specifically to create good cash flow and would have as little as a few hundred dollars equity in a wrap that might pay 2-3 hundred dollars a month in cash flow.

EXAMPLE THREE - 20k down and a wrap by an AITD.

The terms would be identical as example two. The difference is just the documentation. In most states a contract for deed most resembles a mortgage and has similar foreclosure laws. Some states have adapted contracts to be more like trust deeds. Some states rarely use them and much of the time a contract is NOT the best way to go, but that depends on the state and is NOT a universal rule.

An AITD is just a wrap in the form of a trust deed. Foreclosure laws also vary by state, but usually a trust deed is more desirable and cheaper, quicker and easier to foreclose.

So, “wrap” is terminology describing a transaction. A “Contract for Deed” is one form of wrap. An AITD is another form of wrap. In the case of a wrap, generally the existing loans are not assumed and are still in the name and responsibility of the seller. The permission or cooperation of the lender of the existing loan (called the “underlying loan”) is not needed or essential to the transaction. The lender may have rights to call their loan if a property is sold via a wrap. This is called an “Alienation clause” or “Due on Sale” clause.

It is NOT illegal to sell or buy on a wrap, though some try to say it is. A lender on an underlying loan cannot stop or dictate terms on the sale of a property. They may have a contractual right to call their loan due if the property is sold.

In many states, real estate agents are warned NOT to do wrap around loans where there is a due on sale clause. It can be considered a breach of ethics by their licensing division and they can threaten them with the loss of their license. In other states they have not tried to dictate to agents that they can’t be involved in wraps with DOS clauses, but they have specific disclosure forms and procedures to help protect people. They make the potential risks and liabilities clear and sometimes have signed agreements between buyer and seller related to how potential liabilities are handled.

I’m not trying to start up another conversation on DOS clauses or to discuss pros, cons, legal remedies, etc. I am just pointing out that in some areas agents are warned, pressured and threatened regarding DOS clauses and wraps. Sometimes agents hear that wrong and will tell people wraps are illegal. Long before the Due On Sale debate and battles, I lost track of how many intellectually challenged agents tried to tell me (a broker) that contracts were “illegal”. Translated that means they don’t know what contracts are, don’t know what they are talking about and yet can’t control the pathway between their small brain and their large mouth. I’ve had to sit and argue with or try to educate some of these "D’ students of real estate and even had sellers turn to their own agent and correct them. In many cases I have had to call the broker in to straighten out their own agent. I was more mellow and tactful in those days. Now I would probably correct them in a very intimidating and blunt manner.

Re: aitd/wrap question - Posted by Joe Kaiser

Posted by Joe Kaiser on April 11, 2006 at 20:28:57:

Adam, know that they’re pretty much two different things. No aka here.


Re: aitd/wrap question - Posted by dutch

Posted by dutch on April 11, 2006 at 15:45:12:

Are you looking for live contracts? Or just a flow chart of how it works?


Re: aitd/wrap question - Posted by rick m

Posted by rick m on April 11, 2006 at 23:00:32:

When you do a wrap using your example 2 how do you structure the insurance? A new policy w/ a new beneficiary could trigger the acceleration clause right? And simply changing the beneficiary on the old policy probably wouldn’t provide enough coverage would it? I am a bit confused how to handle that part of it. Thank you for all your help!

Re: aitd/wrap question - Posted by adam

Posted by adam on April 11, 2006 at 22:24:36:

can you give me an example?