A wraparound mortgage is a unique loan arrangement where an existing loan is retained, and an additional, larger loan is provided. This new loan “wraps around” the existing loan, with the new lender (typically the seller of the property) assuming the obligation to make payments on the old loan.
Key Characteristics of Wraparound Mortgages
Structure of a Wraparound Mortgage
A wraparound mortgage, also known as an all-inclusive trust deed (AITD), is structured as follows:
- Existing Loan Retained: The original loan remains in place and is not paid off.
- New, Larger Loan: A new loan is created, usually by the seller, which is larger than the remaining balance of the original loan.
- Payment Obligations: The buyer makes payments to the new lender (seller), who in turn continues to make payments on the original loan.
Interest Rates and Yield
The existing loan often carries a lower interest rate than what is currently available on new loans. This difference allows the wraparound lender to achieve a higher yield.
Benefits to the Seller
Sellers utilize this method primarily to facilitate sales in a high-interest-rate environment. Given that wraparound mortgage rates are typically lower than prevailing rates, this arrangement can be attractive to buyers.
Applicability in Installment Sales
In an installment sale involving a wraparound mortgage, the seller does not decrease the contract price by the amount of the underlying mortgage. This can aid in achieving more favorable tax treatment and provides the seller with ongoing income from the mortgage payments.
Historical Context of Wraparound Mortgages
Emergence and Use
Wraparound mortgages gained popularity in periods when real estate market conditions made traditional mortgage financing either challenging or expensive due to high-interest rates. Their flexible nature allows for easier negotiation between buyer and seller, catering to specific financial situations.
Legal Considerations
It is crucial to ensure that the original loan’s terms do not have a “due on sale” clause, which could call the loan due in full upon transfer of property title. Legal advice and clear contracts are essential to navigate these nuances.
Examples and Case Studies
Case Study: Residential Property Sale
Consider a homeowner with an existing mortgage balance of $200,000 at a 4% interest rate. They decide to sell their home for $400,000, offering a wraparound mortgage at a 6% interest rate. The buyer makes payments on the $400,000 loan to the seller, who pays the existing mortgage and keeps the difference. This provides a higher yield to the seller and potentially more favorable purchase terms for the buyer.
Related Terms
- Installment Sale: A sale permitting the buyer to pay the purchase price over time in installments.
- Contract Price: The agreed-upon price in a sale contract, not reduced by the amount of the existing mortgage in wraparound scenarios.
FAQs
Q1: What are the benefits of a wraparound mortgage for buyers?
Q2: Can any property be sold using a wraparound mortgage?
Q3: Are there risks associated with wraparound mortgages?
Summary
Wraparound mortgages provide a flexible, innovative solution in real estate transactions, particularly beneficial in high-interest-rate environments. By retaining an existing loan and creating a new, larger loan, sellers can facilitate property sales while receiving higher yields. However, careful legal and financial planning is essential to ensure a successful wraparound mortgage agreement.
References
- Real Estate Principles: A Value Approach, David C. Ling & Wayne R. Archer
- Investing in Real Estate, Andrew McLean & Gary W. Eldred
- Mortgage Financing, Vicki L. Van Ness
Providing comprehensive coverage of the topics enhances understanding and ensures that readers are well-informed about the intricacies of wraparound mortgages and their practical applications.
