Sub2 and "wrap" keep getting used for the same deal

Question

Been talking to a seller about a house on a double lot (the lot is honestly the part I want). His agent told me the seller would "wrap" his loan to me, then in the next sentence called it a subject-to. I asked which one and got "same thing, just different words for taking over payments."

That doesn't sound right to me but I can't say why. The loan is a 3.25% from a few years back, balance somewhere around 240k, and he thinks his equity is about 40k. If it's the same thing, why are there two words? And in either version, what am I actually bringing to closing, because everything I read says these are low-cash deals and 40k isn't low cash to me.

Rena Guide · Accepted Answer

They're related but they're not the same deal. Two words, two structures.

Subject-to means the deed transfers to you and the seller's existing loan stays in his name, at his rate, and you make those payments. There's no new loan created between you and him. If you pay him for his equity over time, that's a separate small note, and it sits alongside the deal rather than replacing anything.

A wrap, short for wraparound, also leaves the underlying loan in place, but the seller creates a brand new note to you that wraps around it. You pay the seller on the new note. The seller pays his lender out of what you send him. Sellers like wraps because they can write the new note at a higher rate than the underlying and keep the difference. So on your numbers, he could wrap 280k at 6% while his own 3.25% loan keeps running underneath, and pocket the spread every month.

The loose usage you ran into is real. Plenty of people call any deal where the old loan stays in place a "sub2." When someone says that word, ask whether a new note is being created and who mails the payment to the lender. Those two answers tell you which structure you're actually in.

Cash-wise, the 40k is the seller's equity, and it's negotiable, financeable, or sometimes much smaller when a seller is behind on payments. You'll also fund reinstating any arrears, closing and attorney costs, and the escrow the lender holds. Recording and disclosure rules for these transfers vary by state, so have a real estate attorney in that state paper it.

raj_mehta14 · Answer

The spread part is the bit that snagged me. If the seller writes you a 280k note at 6% over his own 3.25%, that new note is paper he owns, right? Which means somebody could buy it off him later at a discount. That's the whole thing I've been reading about and I hadn't connected it to these deals until now. Does anyone actually buy wrap notes, or is a note sitting on top of a loan nobody's supposed to know about too ugly to sell?

Rena Expert · Answer

@vellum, wrap notes do trade, at deeper discounts than clean seller notes, because the buyer of that paper inherits a payment chain with a senior loan underneath that can be called. Price reflects that.

@parcel, the practical difference between the two structures for you is control of the payment. In straight subject-to you can send money to the servicer yourself or through a third-party servicing company, and you see the loan history. In a wrap you're paying the seller and trusting him to forward it. If he doesn't, the loan goes delinquent, the credit damage lands on him, and the default lands on your property. People manage that by having a licensed loan servicing company collect from you and pay the underlying lender directly, which costs somewhere in the range of a small setup fee plus roughly ten to thirty dollars a month depending on the company. Get the fee schedule in writing before you sign anything.

The second thing a wrap does that people miss is create a term mismatch. If the seller writes you a 30 year amortization on the wrap and the underlying has 26 years left, the underlying pays off first and you're still paying him for four years on a loan with nothing under it. Conversely if he balloons you in five years, you need the refinance to work at whatever rates exist then, on a property you bought with a 3.25% payment baked into the numbers.

Both structures move the deed, so both touch the due-on-sale clause. The wrap doesn't hide anything from the lender that subject-to doesn't.

One more thing on his 40k. Ask what he owes in back payments, taxes, and any liens. That number often eats the equity he thinks he has, and it changes the conversation.

dpatel_re · Answer

First thing I'd pull on that 240k balance is the loan's origination date and remaining term. A 3.25% loan with 27 years left is worth taking over. A 3.25% loan with nine years left has a payment that's mostly principal, and the monthly number will look terrible against rent even though the rate is beautiful. People fall in love with the rate and never check the amortization.

Sub2 and "wrap" keep getting used for the same deal

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