Chapter 10 GAIN LEVERAGE ON EXISTING FINANCING WITH A WRAPAROUND MORTGAGE Flashcards
1
Q
What is the goal of this chapter?
A
To acquaint you with the wraparound mortgage and its benefits in increasing leverage and closing transactions.
2
Q
Define a wraparound mortgage.
A
A new mortgage that combines the new loan amount and one or more existing loans, typically held by a seller.
3
Q
What is a purchase money wraparound mortgage?
A
A wraparound mortgage that is specifically created to facilitate a purchase transaction.
4
Q
In the example of Sam and Bruce, what is the total amount of the wraparound mortgage?
A
$175,000
5
Q
What are the monthly payments Bruce must make under the wraparound mortgage?
A
$1,822.68
6
Q
What is the annual interest rate on the wraparound mortgage in the Sam and Bruce example?
A
9.75 percent per annum
7
Q
What is the balloon payment amount due at the end of the 10-year term in Sam and Bruce’s example?
A
$94,065.00
8
Q
How much money does Sam ultimately receive from the wraparound mortgage by the end of 10 years?
A
$111,028.92
9
Q
What is the yield on Sam’s $35,000 investment in the wraparound mortgage?
A
Approximately 12.24 percent per year
10
Q
What are the benefits of a wraparound mortgage for buyers and sellers?
A
Increases leverage, facilitates transactions, and can shift assets to later years.
11
Q
True or False: Wraparound mortgages are commonly understood by all parties involved.
A
False
12
Q
In the example of Bobby and Jeff, what is the purchase price of the condominium?
A
$220,000
13
Q
What is the existing first mortgage amount in Bobby and Jeff’s transaction?
A
$150,000
14
Q
What is the interest rate of the existing first mortgage in Bobby and Jeff’s example?
A
6.5 percent per annum
15
Q
How much does Bobby offer as a down payment?
A
$25,000
16
Q
What is the monthly payment of the wraparound mortgage that Jeff offers to Bobby?
A
$1,462.50
17
Q
What is Jeff’s cash flow on the equity portion of the wraparound mortgage?
A
$3,390.00 per year
18
Q
Calculate Jeff’s cash flow yield on the equity difference of $45,000.
A
7.533 percent
19
Q
What is the remaining balance on Jeff’s existing mortgage after 10 years?
A
$88,114.50
20
Q
What is Jeff’s total earnings from the wraparound mortgage after 10 years?
A
$61,847.10
21
Q
Fill in the blank: The wraparound mortgage allows buyers to purchase a property by _______ the seller’s existing financing.
A
[assumingly taking over]
22
Q
What is a significant challenge when using a wraparound mortgage?
A
Misunderstanding its mechanics by buyers, sellers, and lawyers.
23
Q
What can the wraparound mortgage help facilitate for sellers?
A
A creative way to build wealth and shift assets.
24
Q
What happens to the yield if there is an early repayment of the debt?
A
The bonus will be unknown until calculated at the time of repayment.
This concept is similar to a discounted mortgage where earlier repayment results in a greater final yield.
25
What is the cash flow yield for Jeff's invested equity in the wraparound mortgage?
7.533 percent return
## Footnote
This yield is calculated from the cash flow of $3,390.00 on an investment of $45,000.
26
What is the total amount Jeff will collect after 10 years if the wraparound mortgage is paid off?
$106,847.90
## Footnote
This amount includes the return of his original investment of $45,000 plus a bonus.
27
How do you determine the interest rate that caused $45,000 to compound to $106,847.90 over 10 years?
By dividing $106,847.90 by $45,000 to find the target in Table C under the 10-year column.
## Footnote
The closest match was 9 percent, indicating Jeff's yield was slightly above 9 percent.
28
What is the approximate total return on Jeff's invested $45,000?
16.653 percent return
## Footnote
This total return comes from combining the cash flow yield and the yield from the principal compounding.
29
What is the most important factor about wraparound mortgages?
A wraparound mortgage is just a tool with many uses depending on knowledge and goals.
## Footnote
It can be beneficial or irrelevant based on the specific situation.
30
What are the characteristics of a wraparound mortgage?
1. Not a cure-all form of financing.
2. Never in first position.
3. Not required to enclose all existing mortgages.
4. Not all the same; varies by transaction.
31
What is an example of a wraparound mortgage transaction involving Al and Robert?
Al wants to purchase Robert's property with existing financing and a seller-held wraparound mortgage.
## Footnote
The transaction includes multiple mortgages, illustrating the complexity of wraparound arrangements.
32
What was the structure of Paulsen's wraparound mortgage?
Wraparound of $115,000 at 10 percent for a 20-year term.
## Footnote
Paulsen receives a monthly payment of $482.44 after deducting the existing mortgage payment.
33
How is the yield on Paulsen's mortgage calculated?
By finding the constant rate on the payment towards the difference of $40,000 over 20 years.
## Footnote
The yield was determined to be approximately 13.45 percent per year.
34
What should be considered if a wraparound mortgage is paid off early?
There can be substantial bonuses to the holder of the wraparound mortgage.
## Footnote
Early payoff can lead to unexpected financial benefits for the lender.
35
What is the effective yield when a wraparound mortgage is paid off early?
The effective yield would be approximately 13.692 percent per annum.
## Footnote
This yield is higher than the original yield of 13.45 percent.
36
What happens when a wraparound mortgage is paid off early?
The holder of the wraparound mortgage can receive a substantial bonus.
## Footnote
This is beneficial for the holder if the property is sold and refinanced.
37
In the example provided, what was the original amount of the wraparound mortgage?
$115,000.00
## Footnote
This was compared to an existing mortgage of $75,000.00.
38
What was the interest rate of the wraparound mortgage?
10%
## Footnote
The existing mortgage had an interest rate of 8%.
39
What is the annual payment for the wraparound mortgage?
$13,317.55
## Footnote
The existing mortgage had an annual payment of $7,527.75.
40
What is the remaining term for both the wraparound and existing mortgage at the end of the first year?
19 years
## Footnote
Both mortgages had 19 years remaining.
41
How much was still owed on the wraparound mortgage at the end of the first year?
$113,100.21
## Footnote
The existing mortgage owed was $73,412.81.
42
What is the net interest earned by Paulsen for the first year?
$5,476.64
## Footnote
This is the difference between total payments received and the original principal amount.
43
What are the most common uses of a wraparound mortgage? List at least three.
* Leveraging a seller's position upward
* Inducing the seller to hold secondary paper
* Providing an effective solution when existing financing has prepayment difficulties
## Footnote
Each use highlights the advantages of wraparound mortgages in various financial scenarios.
44
True or False: A wraparound mortgage requires the buyer to assume the existing financing.
False
## Footnote
The wraparound mortgage does not require assumption of existing financing.
45
What can be a major problem when refinancing existing financing?
Refinancing costs
## Footnote
The wraparound mortgage may be less costly to administer than obtaining new financing.
46
How can a wraparound mortgage help with properties that have multiple existing mortgages?
It can consolidate multiple mortgages into one payment.
## Footnote
This simplifies payments for the buyer.
47
Fill in the blank: The 'difference' in wraparound terms refers to the amount of the total wraparound mortgage after deducting the ______.
amount owed on the existing financing
## Footnote
This 'difference' represents the equity the seller or mortgagee has.
48
What happens to the 'difference' in a wraparound mortgage over time?
It normally grows in the early years before beginning to decline.
## Footnote
This reflects the mortgagee's equity earning interest that is not paid.
49
What was the face amount of the wraparound in the Hodges case?
$2,150,000
## Footnote
This was part of a larger transaction involving a shopping center.
50
What was the interest rate for the wraparound in the Hodges case?
9 percent per annum
## Footnote
This was compared to lower rates on existing mortgages.
51
What is the benefit of marketing a property with sound financing?
It can lead to a quicker sale and less negotiation on price.
## Footnote
Properties with manageable financing ratios are more attractive to buyers.
52
What effect does a short balloon payment in existing financing have on selling property?
It can create difficulties in selling the property.
## Footnote
A wraparound may provide a solution if refinancing is not feasible.
53
What was the annual payment for the second mortgage?
$ 81,781
54
What is the face amount of the wraparound mortgage?
$ 2,150,000
55
What is the original difference in the mortgage calculations?
$ 250,000
56
What is the total payment allocated to the difference at the start?
$ 33,259.50
57
At the end of the first year, what is the balance owed on the wraparound mortgage?
$ 2,107,967
58
What is the principal paid on the wraparound mortgage by the end of the first year?
$ 42,032
59
By the end of the first year, how much has the original difference increased?
$ 14,241
60
What is the total interest on the wraparound mortgage at the end of the first year?
$ 47,500
61
What was the balance applicable to the difference at the end of the second year?
$ 279,048
62
True or False: The balance applicable to the difference decreases each year.
False
63
What is the cash flow yield shown in the analysis for the first 15 years?
$ 33,259.50 per year
64
What is the effective return to the holder of the wraparound mortgage after 15 years?
13.30 percent
65
What happens to the difference at the end of the 15th year?
It increases to $ 512,289
66
Fill in the blank: The total effective rate combining cash flow rate and bonus rate is _______.
8.20 percent
67
What is the principal balance of the wraparound mortgage at the end of the 8th year?
$ 1,686,446
68
What is the principal balance of the first mortgage at the end of the 8th year?
$ 881,469
69
What is the total cash flow from the wraparound mortgage for the mortgagee after payments?
$ 33,259.50
70
How does the effective yield on the wraparound mortgage change when the difference drops below its original sum?
It can be treated as an interest-only return
71
What must be calculated to determine the actual interest rate causing the growth of the investment?
Target rate
72
What is the total cash flow yield for the wraparound mortgage after all payments on existing financing?
13.30 percent
73
At the end of the 20th year, what happens to the mortgage balances?
All are paid off
74
What is the effective yield on a wraparound mortgage?
The effective yield is the original rate of 13.30 percent plus the bonus rate.
75
What does the retained cash represent in a wraparound analysis?
The retained cash represents the sum of money received net of payments on existing financing less amortization of the difference.
76
What is the total cash received on the difference in the Hodges Shopping Center Case Study?
$33,259.50 for the term of the existing financing.
77
When does the retained cash equal the total cash received?
When there is no amortization of the difference.
78
What is the capitalization rate of the difference in a wraparound mortgage?
The capitalization rate is 13.30 percent for the period when the retained cash is at or above the original investment.
79
When does the bonus amount begin to benefit the mortgagee?
In the fifteenth year, when the build-up of difference stops and amortization begins.
80
What is the function of Column E in the Wraparound Mortgage Analysis Sheet?
Column E shows the balance owed on the difference, which grows if there is no amortization.
81
What does Column F represent in the analysis sheet?
Column F represents the total cash received on the difference after existing mortgage payments are deducted.
82
What should be done in Column G of the analysis sheet?
Column G should contain amounts only for the years when the difference is declining.
83
How is the annual interest rate calculated in a wraparound mortgage?
The annual interest rate is found by dividing the retained interest by the original balance of the difference or by the amount of the difference at the start of that year.
84
What does Column J show in the Wraparound Mortgage Analysis Sheet?
Column J shows the amount of accrual of 'extra lending' or the bonus for that period.
85
What is a significant advantage of a wraparound mortgage for the seller?
Effective yield increases, providing leverage in annual return.
86
How does a wraparound mortgage help in case of default?
The mortgagee is notified first if the buyer falls behind on payments, allowing for early action.
87
Why is a wraparound mortgage a useful selling tool?
It offers terms that may be under current rates and longer than those available at local lenders.
88
What is the potential tax implication of selling a property with a low basis and wraparound mortgage?
Selling may trigger capital gains tax if the financing exceeds the tax basis.
89
Fill in the blank: The retained interest is found by subtracting Column G from Column _______.
F
90
True or False: The wraparound mortgage allows the seller to maintain control over existing mortgage payments.
False
91
What is the amount Barkley currently owes on the property?
$300,000
92
How much debt does Barkley have in excess of his tax basis?
$250,000
93
What is the adjusted gain Barkley would have in the sale?
$425,000
94
How much capital gains tax would Barkley face from the sale?
Over $140,000
95
What out-of-pocket cost would Barkley incur to make the sale?
Over $40,000 plus fees, commissions, and other closing costs
96
What complication arises for Barkley due to his mortgage situation?
He would be taxed on the $250,000 excess at his earned income rate
97
What type of mortgage was established between Barkley and the buyer?
Wraparound mortgage in the form of a contract for deed
98
What is the amount of the wraparound mortgage Barkley established?
$400,000
99
What does the contract for deed require from the buyer?
Meet certain obligations to have the property deeded to him
100
Why is Barkley not relieved of his mortgage debt under the wraparound?
The buyer did not assume the liability
101
What allows Barkley to maintain an installment sale?
He did not receive more than 30 percent of the principal in any year
102
What could be a potential alternative to the wraparound mortgage?
A lease option
103
What is IRC 1031 treatment?
A tax treatment that could avoid immediate tax payment
104
What is one strategy Barkley could use to transfer property ownership?
Gift percentages of interest to children or grandchildren
105
What is a key advantage of a wraparound mortgage for buyers?
Flexibility in terms and potentially lower payments
106
How does a wraparound mortgage help with cash flow for buyers?
Provides a lower total annual payment
107
What is the example provided for a property with an NOI of $200,000?
Cash flow of $50,000 after debt service
108
What is the maximum cash an investor is willing to invest in the example?
$450,000
109
What is the minimum price for the property in the cash flow problem?
$1,600,000
110
What is the constant annual payment percentage calculated in the example?
13.479 percent
111
What is a significant advantage of having a wraparound mortgage?
Ease of payment with only one payment to make
112
What should payments on a wraparound mortgage be made to?
An escrow account
113
What is a critical factor in the escrow agreement for a wraparound mortgage?
Comprehensive instructions for the escrow agent
114
What should the escrow agent cover regarding collections?
Taxes and escrows covered in the wraparound or existing mortgages
115
What must be analyzed in existing mortgages for the wraparound?
Prepayment provisions
116
What is the recommended grace period for a wraparound mortgage?
Shorter than on the existing financing
117
What is a unique problem for a third-party lender in a wraparound mortgage?
Potential automatic foreclosure provisions in existing mortgages
118
What is the effective rate of return on new money at the end of the first year?
12 percent
119
What is the total principal and interest return on wraparound at the end of the first year?
$540,000
120
What amount has the third-party lender lent in this transaction?
$100,000
121
What is the potential problem for the third-party lender regarding usury?
The loan can be null and void if deemed usurious
122
What is the face rate of the wraparound mortgage?
8 percent
123
True or False: The lender has an obligation to pay the original first mortgage of $400,000.
False
124
What must a third-party lender do to avoid potential usury issues?
Assume the full obligation of the existing financing
125
Fill in the blank: Interest earned on the wraparound mortgages will be reported as _______.
income
126
What is the total interest collected at the end of the first year on a $500,000 existing wraparound?
$40,000
127
What is the net difference when deducting interest paid out on existing mortgage?
$12,000
128
What is one sign that indicates a situation is right for the use of a wraparound mortgage?
Existing loan constant annual payment percentage relationship to maximum loan potential
129
What is a forced wraparound?
Existing financing that cannot be assumed and refinancing is not possible
130
What reinvestment goal might make a wraparound attractive to the seller?
Leverage gained on the yield
131
What is the risk associated with the return to the mortgagee in a wraparound?
Return is often postponed until the future
132
What was the total price at which Rodger sold his office building to Alex?
$1,500,000
133
What was the balloon payment amount required by the bank after 10 years?
$816,824.55
134
What was the monthly payment on the wraparound mortgage Rodger suggested?
$10,253.83
135
At the end of 15 years, what was the scheduled balloon amount of Rodger's wrap mortgage?
$488,238.86
136
What was the total annual payments to Rodger after the transaction?
$149,029.80
137
What is the total amount received by Rodger from the wraparound mortgage?
$729,064.80
138
True or False: The wraparound mortgage is only beneficial for the seller.
False
139
What must sellers ensure regarding existing debt when considering a wraparound?
Existing debt allows use of the wraparound
140
Fill in the blank: The wraparound allows sellers to provide additional yield on the ______ they hold.
debt
141
What should sellers disclose to existing mortgagees regarding a wraparound?
The amount of the third mortgage
142
What is one of the drawbacks of the wraparound mortgage from a seller's point of view?
Funds may not be available for use when needed
