Sharp EL733A EL-733A Operation Manual - Page 64

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WRAP-AROUND MORTGAGES A wrap-around mortgage is a second mortgage on a piece of real property that absorbs the first mortgage. The lender in a wrap-around mortgage usually agrees to assume the payments of the first mortgage and lend an additional sum beyond the Present Value of the first mortgage, in exchange for a periodic payment that is either greater than the payment on the first mortgage or that continues for a longer term. The questions that you need to be able to answer to perform a wrap-around mortgage calculation are three in number: 1. What is the Present Value (remaining balance left to pay) on the first mortgage? Usually this is a TVM calculation. 2. What is the payment that the borrower must make on the new wrap-around mortgage? Usually this is another TVM calculation. 3. What is the yield to the lender on the whole scenario? (This is an ERR calculation) So every wrap-around mortgage problem is at least three problems, involving three cash-flow schedules, the last of which is generally an uneven cash-flow schedule that needs to be solved using IRR. What is interesting about wrap-around mortgages is that the lender usually gets a better return on investment than the interest rate on either the first mortgage or the wrap-around. The payment on the first mortgage may have been calculated based on a 10.5% interest rate, the payment on the wrap may be calculated on a 13.5% rate and the overall rate of return may be 15%. It may seem like that is not possible, but... 124 Example: As a lender looking for a fantastic long term investment, you are approached by a person who wishes to borrow against some property and make just one monthly payment. This potential borrower has a single mortgage, written at 10.5% APR, that calls for $1'678.40 end-of-the-month payments with a $32'000 balloon payment immediately after the last payment, which is 79 months from today. The person would like to borrow an additional $50'000. You agree to write a wrap-around mortgage at 12% for 30 years that has a $15'000 balloon. You will assume the payments of the first mortgage and lend this person an additional $50'000. In exchange, the borrower will make regular monthly payments to you for the next 30 years. What is the payment that you will receive from the borrower each month, and what are you yielding by agreeing to wrap the mortgage? 125

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WRAP
-AROUND
MORTGAGES
A
wrap
-around
mortgage
is
a
second
mortgage
on
a
piece
of
real
property
that
absorbs
the
fi
rst
mortgage.
The
lender
in
a
wrap
-around
mortgage
usually
agrees
to
assume
the
payments
of
the
fi
rst
mortgage
and
lend
an
additional
sum
beyond
the
Present
Value
of
the
first
mortgage,
in
exchange
for
a
periodic
payment
that
is
either
greater
than
the
payment
on
the
fi
rst
mortgage
or
that
continues
for
a
longer
term.
The
questions
that
you
need
to
be
able
to
answer
to
perform
a
wrap
-around
mortgage
calculation
are
three
in
number:
1.
What
is
the
Present
Value
(remaining
balance
left
to
pay)
on
the
fi
rst
mortgage?
Usually
this
is
a
TVM
calculation.
2.
What
is
the
payment
that
the
borrower
must
make
on
the
new
wrap
-around
mortgage?
Usually
this
is
another
TVM
calculation.
3.
What
is
the
yield
to
the
lender
on
the
whole
scenario?
(This
is
an
ERR
calculation)
So
every
wrap
-around
mortgage
problem
is
at
least
three
problems,
involving
three
cash
-flow
schedules,
the
last
of
which
is
generally
an
uneven
cash
-flow
schedule
that
needs
to
be
solved
using
IRR.
What
is
interesting
about
wrap
-around
mortgages
is
that
the
lender
usually
gets
a
better
return
on
investment
than
the
interest
rate
on
either
the
first
mortgage
or
the
wrap
-around.
The
payment
on
the
fi
rst
mortgage
may
have
been
calculated
based
on
a
10.5%
interest
rate,
the
payment
on
the
wrap
may
be
calculated
on
a
13.5%
rate
and
the
overall
rate
of
return
may
be
15%.
It
may
seem
like
that
is
not
possible,
but...
124
Example:
As
a
lender
looking
for
a
fantastic
long
term
investment,
you
are
approached
by
a
person
who
wishes
to
borrow
against
some
property
and
make
just
one
monthly
payment.
This
potential
borrower
has
a
single
mortgage,
written
at
10.5%
APR,
that
calls
for
$1'678.40
end
-of
-the
-month
payments
with
a
$32'000
balloon
payment
immediately
after
the
last
payment,
which
is
79
months
from
today.
The
person
would
like
to
borrow
an
additional
$50'000.
You
agree
to
write
a
wrap
-around
mortgage
at
12%
for
30
years
that
has
a
$15'000
balloon.
You
will
assume
the
payments
of
the
fi
rst
mortgage
and
lend
this
person
an
additional
$50'000.
In
exchange,
the
borrower
will
make
regular
monthly
payments
to
you
for
the
next
30
years.
What
is
the
payment
that
you
will
receive
from
the
borrower
each
month,
and
what
are
you
yielding
by
agreeing
to
wrap
the
mortgage?
125