Sub2/Wrap - If the underlying note gets called...

[Bryce Y.]

As I understand it you, the investor, have 2 options:  1) have the end buyer refinance, or 2) pay off the underlying note in full.

For scenario 1, how much time does a bank give to pay off the note?  It will take typically 30-60 days for the end buyer to refinance.  Are banks willing to wait this long?

For scenario 2, if they can't refi here's how I see it.  Let's take an example where the seller is 5 years into a loan with the following terms:

$90,000 original loan amount

5%, 30 year fixed

PI of $483.14

At the end of 5 years (when you purchase it sub2), you will be starting with a balance of $82,645.86.  

Now say it needs no repairs and you do a wrap with the following terms:

$100,000 price with $10,000 down

$90,000 loan

9%, 20 year fixed

PI of $809.75

Five years down the road the bank calls the underlying note due. The balance at that time is $73,207.86. Now assuming you don't have the cash to just pay it off, you find a note buyer to buy the wrap note. The balance at that time is $79,836.34. I have no idea what the going rate is for a SF performing 1st for 5 years, but let's assume 90% of UPB or $71,852.71. So really you would only need to come up with the difference, or $1,355.15.

Even at 80% of UPB you have to come to the table with $9,338.79. This shouldn't be difficult considering you took a $10,000 down payment 5 years ago. Obviously the situation is more grave if the bank calls the note earlier, and consequently less grave if they call it later down the line.

It seems to me as long as you keep adequate reserves this worst-case scenario is not so daunting.  Soooo, what am I missing?

[Cal C.]

I don't think you are missing much if QE goes on forever, thus fairly low interest rates, but if QE ends and Yellen was talking yesterday in front of Congress about ending it sooner rather than later then banks will have an incentive to call loans since they will be able to lend at higher rates.  Lets assume that your wrap loans are at an average of 4.5% but one year after the end of QE the average mortgage rate goes back to a more normal 6.5%.  BTW note buyers are going to be paying you much less than 80% on the dollar, so you are at risk for many of your wrap mortgages being called by the bank.  If they do get called and you don't have the reserves to pay them off then you are going to have to sell them off at a steep discount to note buyers and then pay the rest out of pocket.  I

If you realize that QE is an extreme action by the FED, then you know how much risk you have.