Hi,

First – funny signature for a wrapper (Buy Now – never sell)

The quick answer to your question is you do not include the figure in your Home Loan Analysier program.

Here’s the long answer…

Your operation is similar to many setups I’ve heard about. Let’s break down the process and it will be easier to understand (by the way I am no accountant and I’m sure Steve McKnight could explain this a whole lot better).

Essentially you are running 4 accounts:

#1 – tracks your loan balance from your lender
#2 – tracks your wrappee’s loan balance
#3 – tracks fees charged to you by 3rd parties
#4 – tracks fees charged to your wrappee by you

Basically you want to track how much you owe (to your lenders etc) and how much you collect (from your wrappee)

Let’s use some figures to illustrate this:

You buy a home for:
$150,000
You pay a deposit of:
$15,000
You take out a loan (over 25 years paid weekly) for:
$135,000
At an interest rate of:
7%
And pay a weekly principal and interest amount of:
$220.01

You wrap the home (assume markup of 20%) for:
$180,000
You collect a deposit of:
$15,000
Providing a loan (over 25 years paid weekly) for:
$165,000
At an interest rate (assume markup of 2%)of:
9%
And charge a weekly principal and interest amount of:
$319.30

We then assume that there will be a number of additional expenses that will be need to be covered, for example:

Water rates (paid quarterly):
$195
Council Rates (paid quarterly):
$250
Insurance (paid annually):
$300

This gives us a total of:
$195×4 + $250×4 + $300×1 = $2,080

If we divided this by the number of payments per year (the frequency of the payments) we get:
$2080 / 52 = $40

The $40 is an additional commitment on top of the loan commitment which in our example is $319.30 (the wrappers weekly loan payment amount). This gives us a total weekly commitment of:
$319.30 + $40 = $359.30

Now the important thing to work out here is your priorities. What is the incentive for the wrappee? In my view it would be paying off their loan balance as quickly as possible. Would they place a higher priority on paying their insurance committment or paying off their loan? I’d say they would prefer to pay off their loan. However if the insurance is not paid or council rates – then you have a potential risk to your business (you would be exposed without insurance).

So the priority to you would be to ensure the insurance is paid first (along with the other fees).

So I would prioritise the system to ensure the most critical things are paid first. For example:

#1 Insurance
#2 Council Rates
#3 Water Rates
#4 Loan Interest
#5 Loan Principal (the thing the wrappee wants most)

With such a setup any payment you receive would be allocated in that order (you could track this for individual costs – all lump into 1 management system – in this example we will managee it from from one account), as you can see if the wrappee does not make their full weekly committment (loan payment + $40) then they will not have enough to cover their loan – which means they may fall into arrears.

This system is not meant to be harsh (it is based on the terms of your contract) – what it is designed to do is create a system where the wrappee is encouraged to make a full payment each payment period (in our case each week) – which is only fair and reasonable.

There is one more thing to consider. Cashflow. How do you manage your costs to ensure there is enough funds available to pay them any time they fall due. For example – insurance, is normally paid upfront. So we know at least you will need to collect funds from your wrappee upfront to cover this. Then you will need to ensure there are funds available to cover next years charge. One solution is to ensure payments are made in advance. Here is one possible solution:

1) Add up all the charges for the coming year starting from the day the loan starts. In our case this would be a $2080 charge, charged upfront. If this is excessive. Add up those costs you believe need to be paid upfront (insurance, water charge balance, and then add an additional amount to cover your first quarter – at least).

2) This total is then issued as a fee (to be paid in full) to the wrappee with a due date slightly less than the due date of your own fees (if you have 30 days to pay – ensure their fee is due no later than 25 days). The whole purpose is to ensure your operation is not running into negative cashflow. This will give you a surplus in your account.

3) You then issue your $40 weekly charge (as part of your contract conditions) to build up this surplus over the year to cover your costs when they fall due.

4) Funds you receive from your wrappee, whether they came from the upfront fee or your $40 per week instalments, are recorded in one account (remember account #4 – tracks fees charged to your wrappee by you). And the costs you incur are tracked in another account (#3 – tracks fees charged to you by 3rd parties). At the end of each year you do some housekeeping:

– if the difference between the two accounts results in a negative cashflow you would then issue a fee to cover this and generate some surplus to cover up coming fees (an amount to cover the negative + next quarter’s total).
– if the difference results in a surplus you have two options:
i) you can credit the amount towards the wrappee’s loan balance as an additional loan payment; or
ii) you can maintain the surplus for the next years fee charges. This method will maintain your business and ride out waves. And if the surplus is excessive – reduce the weekly instalment (say to $37 per week).

So how does this work in real life?

Let’s run through the 1st month and see what happens ok?

Let’s assume you settled on the 1st of September 2004. This means the loan with your lender commenced on this date and in parallel so did your wrappee’s loan. The 1st also happens to be a Wednesday – let’s call this day the “draw down date” – the day the loan is drawn down (into your bank then promptly used to buy the house).

Technically you only get charged interest AFTER a full day has passed – so really the first day your commitments start is the day AFTER your draw down date. The 2nd of September is therefore the FIRST DAY of your first payment period. In our case the payment period is 7 days long because you are paying weekly.

This makes the payment period start on a Thursday (first day of the first payment period) and finish on a Wednesday (the last day of your payment period). The important things to note here are:

– your weekly obligations occur of the first day of each payment period (when you are notified)
– your weekly obligations are due on the last day of each payment period (the last day you can make a payment before going into arrears)
– your weekly obligations occur on the same day as your draw down day (loan started on a Wednesday – payments always due on a Wednesday)

Are you with me so far?

Put it this way – the weekly loan payment can be paid anytime before each Wednesday – however after that you are into the next payment period (and a new weekly committment) so therefore you are behind in your payments and therefore in arrears.

So let’s go through our first month and see what happens:

(Remember our accounts:

#1 – tracks your loan balance from your lender
#2 – tracks your wrappee’s loan balance
#3 – tracks fees charged to you by 3rd parties
#4 – tracks fees charged to your wrappee by you)

01/09/04 Draw Down Date

– We get hit for an annual insurance fee for $300 (in truth the insurance would need to be paid during settlement and would be part of your pre-settlement costs to your wrappee – however for this exercise we assume it is due 30 days from date of settlement)
– In your bookkeeping system the balance of account #3 is minus $300 (-$300) to show that there is an outstanding charge.
– There is also a water charge for $80 (balance from previous owner)
– In your bookkeeping system we reduce the balance of account #3 to minus $380 (-$800) to show the total outstanding charge.
– We issue a fee (to be paid in full) due in 25 days for a sum of $900 ($300 insurance + $80 water + $520 = 1/4 of annual charge)
– In your bookkeeping system the balance of account #4 is minus $900 (-$900) to show that there is an outstanding charge.

02/09/04 First day of the first payment period

– $220.01 now needs to be paid by YOU to your lender before/on next Wednesday (08/09)
– In your bookkeeping system the balance of account #1 is minus $220.01 (-$220.01) to show that you owe this but have yet paid.
– $359.30 now needs to be paid by your wrappee to your before/on next Wednesday (08/09)
– In your bookkeeping system the balance of account #2 is minus $319.30 (-$319.30) to show that there is an outstanding loan charge.
– At the same time you decrease the balance of account #3 by $40 to minus $940 (-$940) to show that their obligation is increasing.

07/09/04 Second last day of the first payment period

– $359.30 is paid by your wrappee

Remember our priorities? now you have to determine – from your contract setup – how this money is managed. For example it would be fair to say that under the agreement periodical payments (their regular weekly payments) will be collected and allocated ONLY towards their instalment fees ($40/wk) and their loan payments.

For fees issued to them that are due in full. These are paid seperately and must be designated as such when paid into the bank account. In our example we could issue a tracking number say FF0001 (full fee 0001). So if we look at the bank account we expect to see sometime prior to the 25th a deposit labelled FF0001.

So getting back to our example we allocate the wrappee’s payment in the following manner:

– $40 is paid into account #4 reducing the balance to minus $900 (-$900).
– The balance of the payment $319.30 is paid into account #2 reducing this back to zero.

08/09/04 Last day of the first payment period

– $220.01 is automatically debited from your bank account by your lender to pay for your own mortgage
– In your bookkeeping system you record a payment of $220.01 which brings the account back to zero.

02/09/04 First day of the second payment period

– $220.01 now needs to be paid by YOU to your lender before/on next Wednesday (15/09)
– In your bookkeeping system the balance of account #1 is minus $220.01 (negative) to show that you owe this but have yet paid.
– $359.30 now needs to be paid by your wrappee to your before/on next Wednesday (15/09)
– In your bookkeeping system the balance of account #2 is minus $319.30 (negative) to show that there is an outstanding loan charge.
– At the same time you decrease the balance of account #3 by $40 to minus $940 to show that their obligation is increasing.

15/09/04 Last day of the second payment period

– $300.00 is paid by your wrappee (you may have noticed that they did not make their full payment)

– The first $40 is paid into account #4 reducing the balance to minus $900 (-$900) – as this is how we prioritise payments.
– The balance of the payment ($260) is paid into account #2 this leaves an outstanding balance of minus $59.30 (-$59.30). Your client is now in arrears.
– $220.01 is automatically debited from your bank account by your lender to pay for your own mortgage
– In your bookkeeping system you record a payment of $220.01 when brings the account back to zero.

16/09/04 First day of the third payment period

You wait until the next day to give your wrappee the WHOLE of the previous day to make any last minute payments. In our example none were made. So the wrappee remains $59.30 in arrears. In some contracts this would be considered a DEFAULT and a default notice would be issued (with a minimum of 30 days to fix up the problem) in other systems you could issue a letter explaining they are in arrears and give them a little time (say 7 days) to fix up the problem before they are formally in default (and in breach of their contract).

– minus $220.01 added to account #1 (balance = -$220.01)
– minus $319.30 added to account #2 (balance = -$378.60). As you can see the arrears is carried forward until it is paid.
– minus $ 40.00 added to account #4 (balance = -$940.00)

18/09/04

– deposit of $900 paid into bank account – transaction is labelled FF0001. This is the payment for the fee issued on the draw down date.
– plus $900.00 added to account #4 (balance = -$ 40.00). So the payment for the insurance is collected.
– plus $380.00 added to account #3 (balance = $ 0.00). So now your own costs have been covered.

At this moment your bank account is actually in surplus because the $900 full fee charge actually includes a surplus of $520 to always ensure have funds to cover at least 1 quarter of costs. However as you can see at the moment account #4 is still in arrears by $40 and the loan is still in arrears by $59.30.

The idea is to maintain surplus to cover problems – if these funds are allocated to the outstanding amounts now and there is a problem later down the road – then your wrappee has no insurance (so to speak) to cover their obligations. And at the end of each year an adjustment can be made anyway. It is possible to reduce the surplus if they are good at meeting their obligations or increase it if their payment history is hap-hazard.

22/09/04 Last day of third payment period

– $450 payment received
– plus $ 40.00 added to account #4 (balance = $ 0.00)
– plus $410.00 added to account #2 (balance = $ 31.40). Since they have over paid the wrappee’s are now $31.40 ahead of their loan obligations – this could also be refered to as equity.
– plus $220.01 added to account #1 (balance = $ 0.00)

The last payment period goes smoothly (I’m sure you get the idea by now). By the way, since the wrappee fixed up the arrears in two days – they were able to recover within the time allowed by the consumer credit code (30 days minimum).

This is a very rough idea of what can be done. As you can see the loan and the fees are managed seperately. Also note that it’s important to determine how payments are allocated and that it is important to maintain a surplus in your business (otherwise your paying with your own money and that is definately not positive cashflow thinking).

Anyway that’s it from me…

Regards
Michael G

Jobee,

You will find with all mortgages it is a condition of the loan that adequate insurance is taken to protect the security. You will find that the same condition is applied to wraps, i.e. its not something that’s optional.

Michael G

Hi,

The Government understands the both sides of the arguement and is working towards a goal that will balance both sides of the equation i.e. protecting consumers through better disclosure and maintaining an environment where those who wish to provide vendor finance may do so.

And the question whether vendor finance and creative funding structures will exist in the future, simply read here for your answer…

http://www.commbank.com.au/personal/homeloans/familyequity.asp

If some of the top 4 bank in Oz see a market for creative financial structures, then I hazard a guess that the government will not ban it. I will be interested to know if this package will be allow in South Australia?

Regards
Michael Gruber
President
Vendor Finance Association