Can someone explain where the money actually comes from in a wrap

I've been trying to understand notes for months and your example is the clearest version of this I've read, so thank you. The bit I still trip on: the seller no longer owns the house but still owes the bank on it. That relationship is what makes my head hurt. They're liable for a loan on an asset they sold.

Your split is right and it's the cleanest way to hold it. 160k of the seller's own equity earning 7%, and 200k of borrowed money earning the 3.9 or so of gap. Call the total something like 17,200 a year of interest received against 8,000 paid.

Where the risk is, since you asked. Three places.

The buyer can stop paying. The seller still owes the bank every month regardless, so a default doesn't just stop the income, it turns the seller into someone paying a mortgage on a house they don't own while they work through foreclosure to get it back. Foreclosure timelines and procedures differ a lot by state and that difference matters more than the rate spread does.

The underlying lender has a due-on-sale clause in nearly every conventional mortgage, which gives them the right to call the loan when the property transfers. Whether a specific transfer triggers it and what the lender does is a matter of the loan documents and state law, so that's an attorney question, and it's why these get written carefully rather than off a template.

And the seller is now the junior claim on their own former house. Their new note to the buyer sits behind the bank's lien. If anything goes wrong, the bank gets paid first.

So it is arbitrage on a mortgage you already have, and you're carrying default risk, a callable senior loan, and a lien position behind that senior loan for the privilege. That's the advanced part. The math is easy and the paperwork is where the deal lives or dies.