Mortgage wrap ("vendor finance")

Information about Real Estate finance provided by the vendor

A mortgage wrap (or "vendor finance") is finance provided by the owner of a property (the "vendor") to the buyer. Typically, the property is first purchased via a mortgage arrangement with a third-party credit provider such as a mainstream home loan institution, then the owner (then referred to as a mortgage wrapper) on-sells the property to the buyer through a second mortgage-style financial contract at a higher price and at a higher interest rate than the wrapper is paying for the first mortgage. In this way, the buyer repays the wrapper who in turn repays the original financial institution, but the buyer ends up paying more due to the marked-up price of the property and the higher interest charged under the contract with the the wrapper. The wrapper can either pocket the money from the buyer's higher repayments or use it to pay off the first mortgage at a faster rate.

Most mortgage wrapping arrangements involve the second buyer paying an interest rate about 2.0% to 2.5% higher than standard home loan rates — although the actual rate can be any amount stipulated by the contract. In addition, the second buyer has no legal claim on the property and is unable to build up any equity in the property until the wrapper has been paid back all money owing.

Until the mortage wrap has been fully paid, the wrapper retains the property title. Therefore, if the second buyer misses a single payment or does anything else to breach the conditions of the contract, the wrapper can end the contract immediately, evict the buyer, keep all monies paid under the contract and sell the property again, effectively leaving the second buyer with nothing. In addition, if the wrapper defaults on the first mortgage or goes bankrupt, their financial institution can acquire and sell the property to settle the outstanding debt without telling the second buyer. The second buyer has no say in the matter or claim on the property even if they have kept to all the terms and conditions of the mortgage wrap.

Mortgage wrappers must be licensed in Western Australia and abide by the Consumer Credit Code, but because the property itself belongs to the wrapper and is not subject to a lease agreement, the buyer's rights are not protected by the Residential Tenancies Act 1987. Therefore, the owner does not, by law, have to provide you with written, advanced notification to enter the property or other requirements provided for in the Act.

Because of their relative expense and the risks inherent in such arrangements, mortgage wraps tend to be used by buyers who cannot get finance via other means. Before you consider entering into a mortgage wrapping contract:

contact a licensed finance broker to identify and evaluate alternative solutions to obtaining finance (for example, you should ask that they check whether you are able to take out a low-interest government loan);
check that the vendor (ie. the mortgage wrapper) is a licensed credit provider;
make sure you understand the contract, and seek independent legal and financial advice before signing anything; and
if you have any doubts about buying a property under a mortgage wrap, do not go ahead with it.