Real Estate Financing Tips

Wraparound Loans

by Marvin Levin

It is likely that you or your clients will be searching for junior financing on a parcel of income property. You have probably had considerable experience with obtaining second loans on income property, but you may or may not have considered “wraparound” loans.  If you have, then you need not read anything further because there is not much we can share with you that you haven’t already learned.

A wraparound loan is sometimes called an “all inclusive” loan.  The best way to describe a wraparound loan might be with a symbolic numerical example:

	Property Value	$100,000
	Existing Encumbrances	$  50,000
	Equity	$  50,000

The owner wants $20,000 of additional financing.  Instead of seeking a $20,000 second loan, the owner seeks a $70,000 all-inclusive first loan.  By the terms of the loan, the lender agrees to pay the existing indebtedness.  So, the borrower makes a payment each month on the $70,000 loan, from which payment the lender satisfies the existing first loan of $50,000.  The lender advances only $20,000.

At first blush, it seems that a junior loan of $20,000 and a wraparound loan of $70,000, less $50,000, is the same.  However, there are some differences that are worth mentioning:

1. The lender might obtain leverage on the all-inclusive loan that is not necessarily available when making a second loan.  For example, suppose that the interest rate on the first loan is 5% and the interest rate on the wraparound loan is 7%.  Then the net income to the lender is approximately as follows:

	$70,000 @ 7%	=	$ 4,900
	($50,000 @ 5%)		($2,500)
	$20,000 @ 12%		$ 2,400

In this example, the lender would earn 12% on $20,000 advanced.  The reason for the increase is that the lender is earning 7% on $20,000 plus a spread of 2% on $50,000 on the existing loan.  Notice that it may be more politic to make a 7% all-inclusive compared to a 12% second.  Obviously, a borrower or lender should not be fooled by this math, however, many brokers have reported to me that there is less resistance in negotiating a 7% all-inclusive compared to a 12% second, even though the economics are substantially identical.

2. A lender using an all-inclusive might feel that it has better administrative control by using an all-inclusive.  For example, the lender knows automatically that the first loan is kept current because the payment under the all-inclusive includes the amount due under the first.  Also, the lender might require under its all-inclusive an impound payment for property taxes, insurance and/or impound for repair and maintenance.
   
   
3. It may be important for the loan in this hypothetical to be arranged by a licensed real estate broker in California.  That would defend against any assertion that the loan violates California usury law.  The usury law of the state in which the property is located and the state in which the loan is made should be considered.
   
   
4. In addition to evaluating the leverage impact on interest earned on funds advanced, the same analysis should be given to loan fees.  In the hypothetical case, a loan fee of 3% of the all-inclusive loan is $2,100, but it is a little over 10% of the net funds advanced.

If you or your clients are interested in obtaining wraparound loans, please contact me.