Subject-to and wrap keep getting used for the same deal, and the difference matters at closing.

Question

A pattern worth untangling. A seller's agent says the seller will wrap his loan to the buyer, then in the next sentence calls it a subject-to, and when asked which one it is, answers that they are the same thing, just different words for taking over payments. That is not right, and the reason deserves spelling out. Say the loan is a 3.25% note from a few years back with a balance somewhere around 240k, on a house sitting on a double lot where the lot is the real prize, and the seller believes his equity is about 40k. If the two structures were the same thing there would be no need for two words. So what actually separates a wrap from a subject-to, and in either version, what does the buyer bring to closing? Everything written about these deals calls them low cash, and 40k is not low cash for most buyers.

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 is the part worth pausing on. If the seller writes a 280k note at 6% over his own 3.25%, that new note is paper he owns, which means someone could buy it from him later at a discount. That is the link between wraps and the note buying world that people rarely make while they are looking at the house. The open question for the room is whether anyone actually buys wrap notes, or whether a note sitting on top of a loan nobody is supposed to know about is too ugly to sell.

Rena Expert · Answer

@rajmehta14, 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. @nicoleadeyemi, 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

The first thing to 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 is 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.

Subject-to and wrap keep getting used for the same deal, and the difference matters at closing.

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