This study investigates the impact of sheathing panel cracks on the structural performance of light-frame, modular-based timber buildings, focusing on the racking stiffness and strength of the individual timber walls in the modules. Previous research has investigated such walls for decades and lead to practical design methods in the harmonized European design code, Eurocode 5. Such hand calculation methods are effective for simple geometries but for walls with openings or complex forms, a correct prediction of stiffness and strength is considerably harder to achieve and load levels where cracks initiate are almost impossible to predict. The paper presents both experimental and numerical studies to investigate how significant cracking in sheathing panels affects the load-carrying capacity of various light-frame timber walls. Finite element simulations using Abaqus are conducted to model the cracking of sheathing panels with the extended finite element method. Moreover, an orthotropic elasto-plastic connector model is introduced for the nail joints. The results indicate that significant cracking of the sheathing panels influences the stiffness and the load-carrying capacity of the wall elements and that the crack initiation and propagation is strongly affected by factors such as the location of openings, the shape of the sheathing panels and the type and position of sheathing-to-framing connections. The numerical results presented align satisfactory with the experimental data particularly regarding load levels at crack initiation and propagation. Furthermore, a parametric study investigates how cracks, orthotropic connector properties and vertical constraint of bottom rails influence the racking strength of different timber walls.