Does the spread actually pay you, or does it just look good on the spreadsheet?

Question

I've been running wrap math on a duplex I own with a 3.9 percent loan on it, about 141k left. If I sold at 215k with 15k down and carried the 200k at 7 percent, the buyer's payment is roughly 1,330 and my underlying payment is roughly 890. So on paper I'm collecting about 440 a month I wasn't collecting before, plus the price I got.

What I can't settle is how to think about that 440. One way to see it is plain income, the reward for lending at today's rate against a loan I locked at yesterday's rate. The other way is that the 440 is payment for a risk I just took on, because my name stays on the underlying note and if the buyer stops paying I'm still writing that 890 check every month.

Both readings produce the same number and completely different behavior. If it's income you spend it. If it's a risk premium you stack it in an account and don't touch it until the note pays off.

I'm posting this in the beginner spirit because I think people see the 440 and hear "free money" and it isn't free, it's just not obvious what it costs. Curious where the room lands.

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 your numbers, thicket. You wrote the underlying payment as 890, is that principal and interest only? If taxes and insurance are escrowed with that lender then your real outflow is bigger and the spread is smaller than it looks. On my four unit the escrow portion moved almost 200 a month over three years and it would have eaten a chunk of any spread I'd priced at closing. Whoever holds the escrow, that number reprices annually and nobody's wrap note reprices with it.

Does the spread actually pay you, or does it just look good on the spreadsheet?

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