Benefits of the
"It is the foundation of seller financing rather than refinancing the property or formally assuming the existing mortgage.
"The buyer uses a contract as the purchase instrument. Technically he does not get title to the property until he has performed according to the provisions of the agreement.
"In effect, he says to the seller,
"'I’ll pay your equity off in installments over time. And as soon as I have paid everything off, you will give me the deed for the property, and it will be mine.
"'In the meantime, I will act as the owner by taking over the management and getting all the tax benefits and the appreciated equity above what the property is worth at the time of purchase. Of course, all the expenses in the meantime are mine as well.'"
"If the property is free and clear at the time of purchase, the seller pockets all the installment payments on the contract.
It 'wraps around' the existing first and subsequent mortgages or trust deed.
"When the seller receives the installment payments, he has to first make payments on the existing notes before he can pocket the rest. The advantage to him is that the interest rate on the total wraparound contract will be higher than on the underlying loans.
"Therefore, he will be making an interest spread on the underlying part of the note – not a bad deal for a seller-turned-lender.
"In addition, he will be able to spread his capital gains profit out over time rather than receiving all of it during one year. The tax advantages are considerable.
"With the recent liberalization of installment sale provisions by the IRS, sellers have great leeway in how contracts are set up for maximum tax benefits. A competent tax accountant can spell out the detail."
"The advantage to the buyer is that he does not need to come up with a large cash down payment. Frequently, a moderate amount down will close the deal.
"In addition, the interest rates acceptable to sellers are usually far below conventional market rates for new financing.
"In practice, a contract sale is bandied by an escrow company, which holds the pre-executed deed from the seller in favor of the buyer until the latter satisfies the terms of the contract.
"Generally the escrow or title company will also hold a quitclaim deed made out by the buyer in favor of the seller, which is to be released to the seller in case of default.
"It is in the best interests of the buyer if the escrow company is making the payments on the underlying loans before disbursing the balance to the seller. That way the buyer can be assured that his money winds up in the right places."
"An alternative form of the 'contract wrap' technique is the situation where a buyer takes title subject to the existing financing (agrees to take over the seller’s obligations) or goes through the formal procedure of assuming the existing financing (qualification, credit checks, transfer of title).
"The buyer then signs a contract with the seller for the equity above the existing loans and makes payments according to a mutually agreeable schedule. A note secured by the property itself covers the seller’s equity.
"The usual term for this arrangement is 'owner carry back'. The term refers to the fact that the seller carries back paper to cover the unpaid equity on his property. Terms on the paper are negotiable and vary from case to case."
As you can see from Robert Allen's explanation, a contract or wraparound mortgage can be your ticket to successfully investing in real estate, even when cash is tight.