This post is my third in a series sparked by pending legislation in the Texas Senate. Last time, I explained how wrap-around mortgages (or wraps) work. Today, I want to talk about how investors use them. I’m not going to sugar coat. Unscrupulous sellers can take advantage of unsophisticated or unwary people using this technique. So I want to explain how ethical sellers, including investors, can protect their buyers.
Based on our turducken example, investors would probably fall into the role of either John or Greta, owner-financing a house for someone who couldn’t buy it with more orthodox financing. They may also act as a third-party middleman who takes a fee for bringing together the seller and a buyer who needs financing under what Phill Grove calls the Assignment of Mortgage Payment System (AMPS).1
So here’s what to look out for. A reputable seller or investor will use a mortgage servicing company and close with a title company. A scammer, not so much. The title company issues a title policy on the property and handles all of the legal paperwork for the transaction. The mortgage servicing company provides a plethora of benefits to buyer and seller alike, including:
- Collecting the payments from the buyer and ensuring all of the mortgage payments are satisfied.
- Managing an escrow account for the buyer, if one is not part of the original mortgage, to ensure taxes, insurance, and other expenses are paid.
- Notifying all parties if any payments are missed or late.
- Reporting interest income and payments to the IRS.
- The seller gets a 1099-INT to report interest income.
- The buyer gets a 1098 to report interest payments and to document their potential deductions.