Does a wrap's monthly spread actually pay the lender, or just look good on paper

Question

Take a duplex with a 3.9 percent loan on it, about 141k remaining. Sell at 215k with 15k down and carry the 200k at 7 percent. The buyer's payment lands around 1,330 and the underlying payment is roughly 890. So on paper the seller is collecting about 440 a month that wasn't there before, plus the sale price. How to think about that 440 is the real question. One way to see it is plain income, the reward for lending at today's rate against a loan locked at yesterday's rate. The other way is that the 440 is payment for a risk being taken on, because the seller's name stays on the underlying note, and if the buyer stops paying, the seller is still writing that 890 check every month. Both readings produce the same number and should produce different behavior. Treated as income, it gets spent. Treated as a risk premium, it should be stacked in an account and left untouched until the note pays off. This distinction matters most for people newer to wraps, because seeing 440 and calling it free money misses the point. It isn't free. It's just not obvious what it costs until something goes wrong.

karen_whitfield · Answer

Your 440 is payment for keeping your name on someone else's payment habit. I'd treat it as reserve for the first couple of years and then reassess once the buyer has a real record. On land wraps I've carried, the first eighteen months tell you almost everything about the payer, and the ones who go sideways go sideways early. The spread that survives that period is the one you can start thinking of as income.

renee_dubois · Answer

Small thing on the numbers here. Is the underlying payment of 890 principal and interest only? If taxes and insurance are escrowed with that lender, the real outflow is bigger and the spread is smaller than it looks. On a four unit, an escrow portion can move by close to 200 dollars a month over three years, which would eat a chunk of any spread priced at closing. Whoever holds the escrow, that number reprices annually and a wrap note doesn't reprice with it.

Does a wrap's monthly spread actually pay the lender, or just look good on paper

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