Purchasing properties subject to the existing lien, then selling the property utilizing a wrap note can be a lucrative method of investing in real estate if done correctly and the numbers make sense. However, if you decide to sell your wrap note, problems and disappointments might arise if the underlying note calls for escrow to pay for taxes and insurance, and the wrap holder is collecting escrow also from his/her payor. The problem arises when the Note Buyer purchases the wrap note, the underlying note will be paid off. If there is an escrow balance on the underlying note, the bank will send that refund to the original borrower, NOT THE WRAP HOLDER. Likewise, the wrap purchase price will be minus any escrow the wrap holder is collecting from his/her payor.

I am working on two notes which are good examples of problems and issues that can arise. For simplicity, I will use round numbers, to convey the concept.

Say a real estate investor purchased a property for $100,000 subject to an existing mortgage of $100,000 with payments of $700 principal and interest for 240 months. Escrow payments of $200 are added to the payment to cover taxes and insurance for a total of $900.

The real estate investor sells the property for $130,000 with $10,000 down and carries a wrap note for $120,000 for 360 months with payments of $1,000 monthly. The wrap holder also adds $200 in escrow payments to pay for taxes and insurance, making the total payment $1,200. The payor will pay the wrap holder $1,200 INCLUDING escrow taxes and insurance, and the wrap holder will pay the underlying payment of $900 INCLUDING escrow for the taxes and insurance for the underlying lien. Our wrap holder will keep the difference in cash flow of $300.

Six months have passed and our wrap holder goes to a Note Buyer who agrees to purchase the wrap note of $120,000 with principal and interest payments of $1,000 for 354 months for $110,000 minus any escrow balance. Remember, the escrow is NOT the wrap holder's money. The escrow account belongs to payor to pay for taxes and insurance at the end of the year. So $200 monthly escrow times six months equals $1,200 balance in escrow, which the Note Buyer will deduct from the $110,000 purchase price, leaving a total of $108,800 to the wrap holder.

Here is where it can get confusing. The underlying lien also has $1,200 in escrow balance. However, when paid off, this escrow balance with be refunded to THE ORIGINAL BORROWER, NOT OUR WRAP HOLDER. Why? The wrap holder took the property subject to the existing lien. Moreover, the underlying lien holder was not notified, and as far as they were concerned, the original borrower was making payments . The wrap holder was flabbergasted to find out he/she had been paying escrow to insure the original borrower and the underlying lien holder, and since he/she will not receive any type of refund for the escrow balance, the wrap holder has in effect been paying for insurance and taxes of his/her payor.

The point is buying properties subject to, then selling on a wrap can get very tricky when it comes to insurance. I will let the 'subject to' gurus give advice on how to handle insurance. As a note buyer, I want to point out that when paid off, the escrow balance on the underlying lien will go to the original borrower NOT the wrap note holder.

Things can get more complicated if the wrap note holder is collecting escrow, and assumes the insurance on the underlying lien covers his purchaser, and insurance is not purchased. On one of my notes the wrap holder had assumed this for two years. When he wanted to sell the wrap, not only was the escrow balance deducted from his wrap purchase, but he had to pay out of pocket for insurance for the rest of the year for his payors. Why, because they had paid into escrow to have insurance paid.

On another one of my 'subject to' with a wrap note purchases, the wrap holder had a document signed by the original borrower stating in the event of a payoff, the escrow balance would be paid to the wrap holder. However, the bank holding the underlying lien did not recognize this document and insisted on sending the escrow balance to the original borrower. It was the bank's position that since they had no document in their file, if the wrap holder has a claim to the escrow account; the claim is with the original borrower, not the bank.

Now contrast this situation to one where the wrap note holder is wrapping his/her own note. When paid off, the underlying escrow balance will be refunded to the wrap note holder since, he/she is the original borrower. So even though the payor's escrow balance is deducted from purchase price of the wrap note, the wrap note holder will receive a refund from the bank.

The essence of this article is to point out how escrow accounts on subject to's and selling with a wrap can become complicated. Whether you are buying a wrap with a subject to underlying or selling a wrap with a subject to underlying, be aware the escrow accounts have to be addressed.

If you have questions or comments, be sure to CONTACT ME I get the topics for my newsletters from your input.

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

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I received a couple of request wanting to know my views on the Trans Pacific Partnership, (Don't ya just love the names they come up with?) From here on out I will call it Obamatrade.

The arguments have falsely been put into two categories:
1. Obama needs to have the authority to fast track negotiate trade deals which will benefit "America". I put "America" in quotations because there is no definition of what America is, which I will discuss in a later paragraph.
2. Obamatrade will cost American jobs and needs to be either reformed or abandoned.

Let's start with the basics. Individuals and businesses trade with one another, NOT COUNTRIES. When you buy a shirt manufactured in Mexico, are you buying this shirt from the government of Mexico? And conversely, did the manufacturer of the shirt from Mexico sell their shirt to Congress, or to you? Why do you need government bureaucrats or politicians to dictate your purchasing a shirt?

. In a trade agreement between two individuals, the only criteria is does seller and buyer both benefit from the trade. In other words, under a free market system, you see a shirt at the price and quality that you accept, there is an exchange, no matter where the shirt was made. Both parties acted in their own self interest. How simple.

Contrast this trade agreement between individuals, and a trade agreement dictated by politicians and bureaucrats. In a free market system, individuals act in their own self interest. However, in government dictated trade agreement, whose interest is the government taking? You will hear, "America's" interest, but this is a cop out. By "America's" interest do they mean the manufacturers, the workers, the unions, the consumers, the banks, or government agencies like the EPA or the State Department?

Think about it. From an economic standpoint, since the consumer wants the lowest price possible, and the manufacturer wants the highest price possible, which side does the politician take? Likewise, when workers want the highest wage possible, and the manufacturer wants the lowest wage possible, which side does the politician take?

This particular "free trade" agreement points out better than I could ever dream of how politicians from both sides of the aisle will abandon real free market principles in favor of a managed economy. Both Obama and the Republican hierarchy have stated "If WE do not make the rules, China will". Of course there is no mention of to whom is the "we" that is being referred . The politicians lead us to believe the "we" is America. But this leads us back to the primary economic axiom that individuals and businesses trade with one another, not countries.

The fact that most of congress does not even know what is in the agreement is in itself an example to how low our politicians have fallen. In essence it does not matter what is in it. All government managed trade will benefit one party at the expense of another.All government managed trade agreements abandons free market principles in favor of collectivism. It is that simple.

If asked who are in favor of the "free trade" agreement, you will get different answers depending on who the agreement benefits or protects. Managed trade agreements always produce winners/losers.

Contrast this to real free trade agreements. For example, when you see a shirt or blouse at the store and are satisfied with the quality and price, and purchase it, not caring where it was made. In this transaction there are no losers. The manufacturer sold a shirt at a price that made it a profit, and you purchase a product at a price you deemed fair. No matter where the product was produced, there was no imbalance of trade. You received a product and the manufacturer accepted your money. The "we" in a free market is the willing buyer and seller, not a politician.

When asked if I favor this "free trade" agreement, I first point out that it is NOT a free trade agreement, but rather a managed trade agreement. I am against all managed trade agreements including price supports, minimum wage, restrictions to entry, corporate subsidies and bailouts, and other crony capitalism. It makes no difference who makes up the political "we" setting the rules . It is still collectivism and not free markets.

Whenever politicians interfere in the market process, some will win, but it will be at the expense of others, which is just another form of consuming without producing.

As we all know, CONSUMPTION CANNOT EXCEED PRODUCTION.

I will say that not knowing what is in the agreement is a problem, but it does not matter what is in it. Managed trade contradicts the principles of free markets no matter who is president or how many politicians favor it. It is that simple.

If you have a comment or a topic you would like discussed, CONTACT ME It is from your input I get many of my topics.

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

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