Gift WRAPed From THE NOTE PROFESSOR NOTEBOOK

I call a wrap around mortgage, or wrap for short, a gift because you will be earning interest on money you do not lend. Great gift, don't you think? A wrap around mortgage is also called an All Inclusive Trust Deed, and a "Tootsie Pop" mortgage.

A wrap is nothing more than a junior lien that "wraps" around senior liens.

In essence a wrap works like this. You sell a property which has an underlying lien, and you use seller financing. Instead of the buyers assuming the payments for the underlying lien, and you taking back a second, you would wrap the underlying lien. The buyers would then make you a monthly payment for the entire wrap note. You then would make the underlying payments, and have a cash flow of what is left. Because your wrap lien includes the underlying senior liens, you will be collecting interest on the spread between your junior lien and the senior liens. Hence, the "all inclusive" term. By collecting interest on money you do not lend, you will greatly increase your yield, as we will later plainly see.

For example, if you had a property worth $100,000 with a mortgage of $70,000 you would have equity of $30,000. The $70,000 mortgage is at 7% with payments of $629.18 for 15 years.

Bob and Betty Buyer have offered you $100,000 with 10% down, and want you to finance the rest. You have two options to make this deal work. One is for you to take back a straight second with the Buyers assuming the 1st. The other is to take back a wrap around mortgage, where the Buyers would be paying you monthly payments, and you would be paying the underlying lien. Which would offer you the better yield? Lets' look.

If you structure the deal where the Buyers put their 10% down and assume the 1st lien of $70,000, you would then carry a 2nd of $20,000 dollars @10% interest with payments of $214.92 for 15 years. With this method, you would be receiving a 10% yield. Here is what the Second Lien note would look like:

N: 180
I/Yr: 10
PV: -$20,000
PMT: $214.92
FV: 0

Let's look at what happens if you were to structure this deal using a wrap around mortgage instead of taking back a second. You would be carrying a $90,000 note that would include the senior lien of $70,000, plus the $20,000 you are financing at 10% interest. Your wrap note would look like this:

N: 180
I/Yr: 10
PV: -$90,000
PMT: $967.14
FV: 0

With the $967.14 payment, you would make the underlying payment of $629.18. Subtracting the $629.18 from the $967.14, you will enjoy a cash flow of $337.96. By structuring the transaction as a wrap, you have increased your cash flow from $214.92 to $337.96. That is $123.04 more a month!!!

But PROFESSOR, how is this possible? Both the 2nd lien note and the wrap were at 10%. The answer is simple. In the first example, you are receiving 10% on only the $20,000 you financed. By using a wrap mortgage, you are not only receiving 10% on the $20,000 that you are financing, but also the spread of 3% (10%-7%) on $70,000. This is money you did not lend. Let me say that again, and in another way, in case you did not pick up on it: YOU ARE RECEIVING 3% ON $70,000 THAT WAS NOT YOUR MONEY!!!

Let's see what your yield will be: Remember you have $20,000 loaned out, and receiving a cash flow of $337.96 monthly for 180 months. After we identify the variables, we will solve for %i. Your deal looks like this:

N: 180
I/Yr: 19.09
PV: -$20,000
PMT: $337.96
FV: 0

You will enjoy a yield of 19.09%, while Bob and Betty Buyer are paying only 10%. Do you understand why I call wraps a gift? There is a gift of an extra 9.09%.

There are several ways to structure wraps. This example is the least complicated, where you had N on underlying liens coinciding with the N on the wrap. You could also have the wrap longer than the underlying, where the underlying lien is paid off at some point, and you keep the entire wrap payment. That can be real fun. You could introduce balloons, graduated payments, or an endless amount of combinations. These combinations can give you even extra gifts.

Yes, there are disadvantages to wraps, which is a topic for another discussion. In this lesson, I wanted to point out how a wrap works, and how you can use a wrap to increase your yield.

As always, obtain competent legal and tax advice when venturing into the world of owner financing, especially wrap around mortgages. .

If you try this technique, and it works out, contact me to let me know. I love success stories.

Copyright © H&P Capital Investments LLC
All rights reserved
Tom Henderson a.k.a. THE NOTE PROFESSOR

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I normally stay clear of political topics and concentrate on economic issues. However, politics and economics are often intertwined. Recent events on the debt limit and the government shut down gives rise to an error made by pundits, politicians and even individuals with good intentions. What is the error? Equating individual liberty with democracy. This myth must be dispelled.

It is important to point out that free markets is a system of economics, while democracy is a system of government. They are different type of systems. For free markets to exist, the concept of individual liberty must be the major premise of any governmental authority. With this in mind, it should be noted that free markets and democracy can exist separate from one another.

In other words there can be democracy without individual liberty, as we witnessed with Nazi Germany. Likewise free markets can exist in the absence of democracy, as demonstrated by Hong Kong under British administration.

When the major premise of any society is individual liberty, the concept of property rights necessarily follows. Property rights and individual liberty go hand in hand; in fact they are actually one in the same. There can be no individual liberty without the right to acquire, keep or trade property that you own or acquire. Is it not obvious the economic system of free markets and individual liberty are based on the same concept of property rights?

Contrast the economic system of free markets to democracy. Democracy is a system of government where citizens determine, either directly or indirectly through their representatives, the laws to be enacted, along with the leaders who will administer laws. Many believe the right to vote is the same as individual liberty; but is it?

Suppose a society has free elections, yet the leader or governmental body has the power to confiscate property at will, demand the authority to enter your property at his/her whim, punish those who are critical to government, regulate or control the production and distribution of goods and services, or force or forbid you to buy a good or service. Would you consider this a free society where individual liberty is the major premise of government? Of course not.

Is this not the system we now live under? Along the same line, it should be noted that a favorite talking point of socialists is to point out how democracy is the "will of the people", and the people should be able to determine the distribution of goods and services.

Although this is democracy in action, is it based on the concept of individual liberty and property, or does the will of the people legitimize plunder, and therefore negate property rights, and hence individual liberty? For a more thorough explanation, I suggest you read the classic essay, The Law by F. Bastiat especially the topic "The Choice Before Us".

As an extreme example, did we not have a democracy in our country's early formation? Yet "the will of the people" allowed slavery to be an institution. Does slavery not imply that one will toil and not be able to keep the fruits of his/her labor? The slave master would determine what and how much a slave could keep. Notice I did not say "own" but rather "keep" because the slave master could confiscate anything the slave possessed. In other words, the slave had no property rights, yet he/she lived in a democracy.

The slave master could just as well be a governmental body like Congress, as well as an individual. It should be obvious that democracy is not based on individual liberty or property rights, but merely a system of government where the "will of the people" is supreme, not individual liberty.

When property rights are dismissed "for the common good" or any other reason, individual liberty is the victim. It makes no difference if the majority of citizens favor dismissing the right to property by voting, or if a tyrant decides to confiscate property by force. The right to property will still have been negated.

The primary property right inherent to all individuals is the right to own one's life, and no entity, including a governmental body, or the vote of the majority has the moral right to lay claim to it. When the state, whether it be a single tyrant or a democratic body decides it can lay claim on your property, no matter the intentions, the state has in essence laid claim to your life. Tyranny by ballot has the same outcome as any other system that denies individual liberty.

The difference between democracy and individual liberty is why I am a free market advocate rather than a liberal, conservative or independent. Remember, free markets demand individual liberty to exist. Democracy requires only that people are allowed to vote. Free markets allow the laws of supply and demand to function, while democracy often abandons and distorts the laws of supply and demand in favor of "good intentions", "the common good" or "the will of the people".

This brings me to the topic of the government shut down, Obamacare and the debt. Two of my friends on both sides of the political aisle asked what I thought of the government shut down and Obamacare. When I replied to my Democrat friend I was against Obamacare, her reply was, "Do you not believe in democracy"? Of course, my answer was "I believe in free markets and individual liberty. Obamacare is based on the use of force and the concept of wealth redistribution, as well as it defies the laws of supply and demand. It cannot be sustainable. Moreover, Obamacare negates property rights, and therefore individual liberty." I continued, "Which do you favor democracy or individual liberty? They are not the same." A puzzled look came over her face. "But democracy is freedom", was her reply. She had bought into the idea that voting and majority rule equates to individual liberty. Not true.

On the other hand, my Republican friend was overjoyed when I expressed to him my displeasure with Obamacare. "You are on our side", was his exact words. "Not even close", was my reply. "I believe in free markets and property rights. Obamacare is the antithesis of free markets and completely eliminates individual liberty." I went on, "However, you want to FIX it or replace it with some other program which also is anti liberty and free markets. You believe you have a better idea of how to regulate health care, and indeed the economy as a whole. You profess to be for free markets, yet endorse other programs like Medicare and Medicaid, which major premises is based on the concept of wealth redistribution. Just as with Obamacare, under Medicare and Medicaid, "one group will benefit at the expense of another".

I continued, "Individual rights and property rights are abolished with programs you favor just as with Obamacare. At the same time the health care price system is distorted" I went on, "I remind you that Medicaid and Medicare are contrary to free market principles, and both are going broke, just as all programs that defy the laws of supply and demand."

His reply was similar to my Democrat friend, "But Medicare and Medicaid have the approval of the majority of the people from both the Democrats and Republicans. You do believe in democracy, don't you?" Not when democracy is contrary to individual liberty and property rights, and defies the laws of supply and demand.

Both my Democrat and Republican friends live under the same illusion. They believe the right to vote is the same as individual liberty and property rights. They equate democracy with liberty.

Am I against Obamacare? Yes, but not because this particular program is having problems. I am against Obamacare because it defies the laws of supply and demand and is based on the surrender of individual property rights. At the same time, I am against other programs that are based on the same collectivist concepts, including Medicare, Medicaid and Social Security. All of these programs benefits one group at the expense of another. Defending any of these programs on the grounds that it is majority rule or the will of the people is to abandon the right to own your life to the state, not to mention endorsing wealth redistribution programs. Remember, consumption cannot exceed production

Conclusion: There are two and only two ways to organize an economy; free markets or some form of collectivism. Free markets allow the laws of supply and demand to function, which results in overall prosperity, while collectivism distorts economic laws and results in stagnation at best, and mass poverty at worst. At the same time, for free markets to exist, individual liberty and property rights must be the major premise of any society. Property rights allow individuals to cooperate in voluntary exchanges of values. Nature, in all its wisdom, has dictated the economic system which produces prosperity and abundance is based on individual liberty. Remember, individual liberty and property rights are one in the same.

In contrast, collectivism is based on force and coercion, the opposite of liberty. If a democratic society decides "the will of people" demand that property rights be surrendered in favor of some collectivist principle, no matter how good the intentions, the end result is the decay of not only the economy, but also the deterioration of the concept of that each individual owns the right to his/her life, and no governmental body has the right to lay claim to it. When government places itself superior to the individual, even if by majority rule, the blue print for despotism and economic decay is formed. Tyranny by ballot is still tyranny. Liberty and democracy are not the same.

If you have questions or comments, CONTACT ME

Tom Henderson /a.k.a. THE NOTE PROFESSOR .

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