Wrap Around Mortgage

A wrap-around mortgage is a unique type of financing arrangement commonly used in real estate transactions. It allows a buyer to take on a loan that “wraps around” an existing mortgage, enabling the seller to keep their current mortgage while providing the buyer with the funds needed to purchase the property. This type of loan can be particularly useful when interest rates are high or when conventional financing is difficult to obtain.

In this article, we’ll dive into what a wrap around mortgage is, how it works, its benefits, and some potential risks to be aware of when considering this type of financing.

What is a Wrap Around Mortgage?

A wrap-around mortgage (also known as a “wrap loan”) is a type of secondary mortgage that includes both the existing mortgage and an additional amount to cover the purchase price of the property. Essentially, the new loan “wraps around” the original mortgage, allowing the buyer to make one payment to the seller, who then uses part of the payment to cover the original mortgage.

The wrap-around mortgage consists of two key elements:

1. The Original Loan (or “Underlying Loan”): This is the existing mortgage on the property, which remains in place and continues to be paid off by the seller.
2. The New Loan (or “Wrap Loan”): This is the new loan created for the buyer. It is a larger loan that combines the balance of the original loan and any additional funds needed to purchase the property.

The buyer makes one monthly payment to the seller, who then passes on the portion of the payment used to pay the original mortgage. The seller keeps the difference between what the buyer is paying and what is owed on the original mortgage. This allows the seller to make a profit on the interest, which can be a financial advantage.

How Does a Wrap Around Mortgage Work?

Here’s a simple breakdown of how a wrap-around mortgage functions:

1. The Property: The buyer is interested in purchasing a property where the seller has an existing mortgage.
2. The Wrap Loan Agreement: The buyer and seller agree on the terms of the wrap-around mortgage. The seller’s existing mortgage balance is included in the new loan amount, along with any additional amount that the buyer needs to finance.
3. The Loan Payment: The buyer makes one monthly payment to the seller based on the wrap loan agreement.
4. The Seller Pays the Original Mortgage: The seller uses part of the buyer’s payment to continue paying the original mortgage. The remaining portion is profit for the seller.

For example, let’s say the seller has an existing mortgage balance of $100,000, and the buyer is purchasing the property for $150,000. The wrap-around mortgage would cover both the $100,000 original mortgage and the $50,000 difference. The buyer would make a monthly payment based on the total loan amount (e.g., $150,000), and the seller would use part of the payment to continue paying the original $100,000 mortgage.

Benefits of a Wrap Around Mortgage

There are several advantages for both buyers and sellers when using a wrap-around mortgage:

1. Benefits for the Buyer

   • Easier Financing: Buyers who may not qualify for conventional financing due to poor credit or high-interest rates may find it easier to secure a wrap-around mortgage. The seller may be more flexible with the buyer’s qualification requirements, as the loan is directly between them.
   • Potentially Lower Interest Rates: If the original mortgage has a lower interest rate, the buyer can benefit from paying a lower rate than they would with a traditional loan.
   • One Payment: Instead of managing multiple payments, the buyer only needs to make one monthly payment to the seller, simplifying their financial obligations.

2. Benefits for the Seller

   • Steady Cash Flow: Sellers benefit from receiving regular payments, which can be especially helpful if they are looking for a steady income stream.
   • Maintain Existing Mortgage: Sellers can avoid paying off the original mortgage immediately and may find this arrangement preferable if they are not financially ready to pay off the mortgage in full.
   • Potential for Higher Interest Rates: Sellers may be able to charge a higher interest rate on the wrap-around loan compared to their original mortgage, generating a profit on the difference.

3. Benefits for the Real Estate Market

   • Flexibility in Tight Credit Markets: Wrap-around mortgages can be beneficial when credit markets are tight, or when borrowers are unable to secure conventional financing due to high interest rates or restrictive lending standards.
   • Alternative Financing for Buyers and Sellers: It provides a unique alternative for buyers and sellers who may not be able to complete the transaction using traditional methods.

Risks and Considerations of a Wrap Around Mortgage

Despite its potential benefits, a wrap-around mortgage comes with some risks and considerations for both buyers and sellers:

1. For the Buyer

   • Seller Default: If the seller fails to make payments on the underlying mortgage, the buyer could be at risk of losing the property, even if they are making regular payments to the seller. This is because the original mortgage still exists, and the lender can foreclose on the property if it is not paid.
   • Higher Interest Rates: While the wrap-around mortgage may offer more flexible terms, the interest rate on the wrap loan could be higher than what the buyer would have received through conventional financing, especially if the seller is marking up the rate to make a profit.

2. For the Seller

   • Continuing Mortgage Liability: Although the seller continues to receive payments from the buyer, they remain liable for the original mortgage. If the buyer fails to make payments, the seller is still responsible for paying off the original loan.
   • Difficulty in Selling the Loan: It can be challenging for the seller to sell the wrap-around mortgage or refinance the property, as the original loan may complicate the process.
   • Legal Issues: Some lenders may have restrictions on wrap-around mortgages in the terms of their loan agreements. It’s important for the seller to check with their lender to ensure that the arrangement doesn’t violate the terms of the original mortgage.

Wrap Around Mortgage vs. Traditional Mortgages

Wrap-around mortgages are distinct from traditional mortgages in several ways:

• Traditional Mortgage: The buyer obtains a new loan from a lender, which is used to pay off the seller’s mortgage, and the buyer then makes payments directly to the lender.
• Wrap-Around Mortgage: The buyer takes on a loan that includes the existing mortgage as well as any additional amount needed to purchase the property. The buyer makes payments to the seller, who continues to pay the original mortgage.

One of the key differences is that in a traditional mortgage, the buyer works with a bank or financial institution, while in a wrap-around mortgage, the buyer and seller work directly with each other.

Conclusion

A wrap-around mortgage can be a useful tool for both buyers and sellers in real estate transactions, offering flexibility when traditional financing options are unavailable. Buyers benefit from easier access to financing, and sellers can enjoy steady cash flow while maintaining their original mortgage. However, it’s important to be aware of the risks involved, including the potential for foreclosure if the seller defaults on the underlying mortgage.