An underlying mortgage, often referred to as the first mortgage, is the original loan secured by real estate that is still outstanding when a new mortgage, known as a wraparound mortgage, is created. The wraparound mortgage includes the remaining balance of the first mortgage within its total balance, along with additional funds provided to the borrower.
What is an Underlying Mortgage?
An underlying mortgage is the initial lien on a property, which holds priority over any subsequent loans. In the event of foreclosure, the underlying mortgage is paid off first before any other loans.
What is a Wraparound Mortgage?
A wraparound mortgage (also called a “wrap”) is a type of secondary financing for the purchase of real property. The new lender or seller extends a secondary loan which “wraps around” the existing underlying mortgage.
Where:
- \( L_w \) is the wraparound mortgage loan balance.
- \( L_1 \) is the underlying first mortgage loan balance.
- \( \Delta L \) is the additional funds provided by the wraparound mortgage.
Example of a Wraparound Mortgage
Consider a situation where a property with an underlying first mortgage of $60,000 undergoes a wraparound mortgage for $100,000. The wrap loan “wraps around” the $60,000 and provides an additional $40,000.
Historical Context
Wraparound mortgages became popular in periods of high-interest rates as they allowed sellers to facilitate financing to buyers without the buyer needing to secure a new and possibly more expensive mortgage at prevailing rates.
Advantages and Disadvantages
Advantages:
- Flexible Terms: Easier negotiation between the seller and the buyer.
- Lower Upfront Costs: Buyers avoid the high costs associated with securing a new primary mortgage.
- Continued Low Rates: Buyers benefit from the lower interest rates on the underlying mortgage.
Disadvantages:
- Higher Interest Rates: Generally carries higher interest rates than traditional first mortgages.
- Lender Approval: Often requires approval from the underlying mortgage lender.
Applicability and Considerations
Wraparound mortgages are suitable for:
- Real Estate Investors: Seeking creative financing solutions.
- Property Sellers: Who own their homes outright or have a substantial equity position.
- Buyers with Limited Financing Options: Particularly those with less-than-perfect credit.
Related Terms
- Subordinate Mortgage: A loan that ranks below a first mortgage in priority.
- Foreclosure: The legal process by which a lender attempts to recover the balance of a loan from a borrower who has stopped making payments.
FAQs
What happens to the underlying mortgage during a wraparound mortgage?
Are wraparound mortgages legal?
Can a wraparound mortgage be used for commercial properties?
References
- Smith, J. (2020). Understanding Mortgage Structures. Real Estate Press.
- Johnson, L. (2018). Creative Real Estate Financing. Finance World Publishers.
Summary
An underlying mortgage (first mortgage) is a primary loan that remains outstanding when a wraparound mortgage is added to secure additional funds. The wraparound mortgage incorporates the balance of the first mortgage and provides extra financing, making it a versatile financial tool for real estate investors and buyers needing flexible loan terms.
By understanding the dynamics, advantages, and complexities of a wraparound mortgage, borrowers and lenders can better navigate the financial landscape of real estate transactions.
