Definition
A wraparound mortgage is a type of secondary financing for property that includes, or “wraps around,” the existing mortgage on the property. It is a junior loan that encompasses any existing note due on the property, creating a new sum that reflects both the outstanding balance of the original mortgage and the additional principal loan amount.
How it Works
In a wraparound mortgage arrangement, the seller of the property provides financing to the buyer by issuing a new mortgage that covers the remaining balance on the existing mortgage and adds any additional funds needed for the sale. The buyer makes payments to the seller, who in turn remains responsible for payments on the original mortgage. Typically, the interest rate on the wraparound mortgage is higher than the original mortgage, allowing the seller to make a profit on the difference in interest rates.
The structure of a wraparound mortgage allows the buyer to acquire property without having to secure a new, separate mortgage from a traditional lender, which can be beneficial if the buyer does not qualify for conventional financing.
Key Elements
Principal Amount
The principal amount of a wraparound mortgage represents the sum of the outstanding balance on the existing mortgage and any additional loan amounts added by the seller to cover the sale price.
Interest Rates
The wraparound mortgage usually carries a higher interest rate than the existing mortgage, enabling the seller to profit from the spread between the two rates.
Payments and Repayments
The buyer makes monthly payments to the seller based on the terms of the wraparound mortgage. The seller continues to make payments on the original mortgage.
Benefits of a Wraparound Mortgage
- Easier Financing Access: Buyers who might not qualify for conventional loans can still purchase property through a wraparound mortgage.
- Profit Potential for Sellers: Sellers can earn additional income by charging a higher interest rate on the wraparound mortgage.
- Streamlined Process: It simplifies the process by negating the need for new traditional financing, often resulting in quicker transactions.
Considerations and Risks
- Seller’s Risk: The seller remains liable for the original mortgage. If the buyer defaults, the seller must cover the payments.
- Due-on-Sale Clause: Many original mortgages include a due-on-sale clause that could be triggered by a wraparound mortgage, risking acceleration of the loan unless lender approval is obtained.
- Legal and Regulatory Compliance: Both parties must ensure that the transaction complies with local real estate laws and regulations.
Examples and Scenarios
Example
Suppose a property has an existing mortgage with a $200,000 balance at a 4% interest rate. The seller agrees to a wraparound mortgage with a total of $250,000 at a 6% interest rate. The buyer pays the seller based on the $250,000 mortgage at 6%, while the seller continues to pay the original $200,000 mortgage at 4%.
Historical Context
The wraparound mortgage became popular in the 1970s and 1980s when interest rates and loan qualification criteria made alternative financing methods attractive. They remain a viable option in certain real estate markets, especially where creative financing solutions are necessary or preferred.
Applicability
Wraparound mortgages are commonly used in:
- Real estate investments.
- Transactions involving buyers with poor credit.
- Creative financing scenarios where traditional lending is not feasible.
Comparisons and Related Terms
- Assumable Mortgage: Unlike wraparound mortgages, assumable mortgages allow the buyer to take over the seller’s existing mortgage directly.
- Second Mortgage: A secondary loan subordinate to the primary mortgage, but unlike wraparound mortgages, it does not include the original mortgage in its balance.
FAQs
What is the main advantage of a wraparound mortgage for sellers?
Can a wraparound mortgage be used for any property?
What happens if the buyer defaults on a wraparound mortgage?
References
- Real Estate Finance by Richard Brealey and Stewart Myers - A comprehensive guide on various real estate financing methods, including wraparound mortgages.
- The U.S. Housing Finance System: A Bibliography - Detailed resources on mortgage types and their economic impact.
Summary
A wraparound mortgage is a creative financing tool that benefits both buyers and sellers in specific real estate scenarios. It combines the outstanding balance of an existing mortgage with additional financing provided by the seller, offering flexibility and potential financial gains. However, thorough understanding, legal compliance, and consideration of associated risks are essential for successful implementation.
