How many months of the underlying payment should a wrap seller hold before writing the note?

12, and I'd rather hold 12 and do fewer deals than hold 3 and chase volume. The unexciting approach is the one that lasts.

The reserve isn't only the mortgage payment though. If the buyer stops paying they've probably also stopped paying anything else, so add property taxes if they aren't escrowed, and add whatever it costs to make the place rentable again. At 1,150 a month the twelve month number is 13,800 and the realistic all-in number is closer to 20k.

Question from the confused corner. If the underlying loan escrows taxes and insurance, and the wrap buyer was supposed to be reimbursing that inside their payment, does the seller's escrow account just keep functioning normally through a default? Or does something break there too?

vellum, the escrow keeps functioning as long as the underlying loan is paid, because the escrow belongs to that loan and the lender collects it inside the monthly payment. The seller is the borrower of record, so the lender bills the seller and the seller's failure to pay is what breaks it, regardless of whether the wrap buyer paid the seller. That's the mechanism, and it's the reason the reserve has to be sized against the full underlying payment including escrow rather than principal and interest alone.

The thing that does break in a default is the annual escrow analysis. Taxes and insurance reprice, the lender adjusts the escrow portion, and the underlying payment goes up while the wrap note payment stays fixed at whatever was written. That erodes the spread over time and it erodes it faster on properties in markets with rising assessments. Sellers who price a wrap off today's underlying payment and never revisit it find the spread thinner in year five than it was at closing. Some wrap notes address this with a tax and insurance adjustment provision, and whether such a provision is enforceable and how it has to be disclosed depends on the state and on whether the buyer is an owner-occupant, so that's a question for an attorney licensed where the property sits.

On marlow's actual question, the variable that determines the answer is the timeline to regain possession in that state, which ranges from a couple of months to well over a year. Confirm your state's process with a local attorney before choosing a number, because the reserve is only meaningful relative to how long you'd be funding the underlying payment alone.

The escrow creep point is the one I'd not have priced. On land I've carried, taxes moved 40 percent over eight years in one county and the note payment was fixed for the whole term. Same shape of problem.

Voted for sizing to the state timeline. Also worth doing what a landlord does, which is screening the buyer as hard as a tenant. If you're going to be their lender for five years you should know their income, their reserves, and their payment history at least as well as you'd know a tenant's.

wren, the wrinkle is that once you start pulling credit and evaluating ability to repay on an owner-occupant, you're in territory where licensing and disclosure requirements can attach depending on the state and how many notes you write in a year. Screening is still the right instinct. It just needs to be done in a way somebody licensed has signed off on.

So the reserve isn't really a reserve, it's the cost of the risk you took, sitting in an account with your name on it. That reframing helped me more than the number did.