Wraparound Mortgages Explained: Everything You Need To Know
Lauren Nowacki5-minute read
May 21, 2023
When a buyer can’t qualify for a traditional mortgage loan, it can make for a rough sale for both the buyer and seller alike. While the situation may seem impossible, there may be another financing option for both parties to close the deal.
A wraparound mortgage can get the buyer the financing needed to purchase the home and can even make the seller a profit. However, there are several risks involved, so it’s important to know what you’re getting into before using it to buy or sell a home.
Let’s take a closer look at wraparound mortgages.
What Is A Wraparound Mortgage?
A wraparound mortgage is a home loan that allows the seller to maintain their existing mortgage while the buyer’s mortgage “wraps” around the existing amount owed. As a type of secondary mortgage financing, wraparound loans mean that the buyer will make monthly payments directly to the seller, often at a higher interest rate than the original mortgage.
How Does A Wraparound Loan Work?
In a typical real estate transaction, the buyer purchases the home with a mortgage provided by a mortgage lender. The seller then uses the proceeds of the sale to pay off their existing mortgage on the home.
With a wraparound mortgage, the seller keeps the existing mortgage on the home, offers seller financing to the buyer and wraps the buyer’s loan into the existing mortgage. In this situation, the seller takes on the role of the lender.
The buyer and seller agree to a down payment and loan amount, then sign a promissory note that lays out the terms of the mortgage. After all of that is agreed and signed, the seller then passes title and deed onto the buyer. Though the seller continues to make payments on the original mortgage, they no longer own the home.
The buyer pays the seller a monthly mortgage payment (usually at a higher interest rate), while the seller continues to pay their mortgage payment to the original lender. The wraparound mortgage takes the position of a second mortgage, or junior lien. Because of this position, the original lender can still foreclose on the house if the seller fails to pay the existing mortgage.
The seller usually pays the original mortgage with the payments they receive from the buyer. Most wraparound mortgages will have higher interest rates than a conventional mortgage, so the seller will typically make a profit from the second loan.
Wraparound Mortgage Example
Here’s an example of how a wraparound mortgage is used.
Michaela is selling her home for $160,000 and has an existing mortgage balance of $40,000 at a 4% fixed interest rate. She decides to finance a loan for the buyer, Alex, to purchase her home. Both Michaela and Alex agree to a $10,000 down payment and $150,000 wraparound mortgage from the seller at a 6% fixed interest rate.
Alex pays Michaela monthly for the second mortgage, which Michaela uses to pay off her original mortgage and keeps the difference between the two payments. Thanks to the 2% difference in interest rates, Michaela makes a profit.
The Benefits Of Wraparound Mortgages
Making a profit is one reason a seller may agree to a wraparound mortgage. Another reason is that these types of loans can help sellers who are having difficulty selling their homes. It helps open the pool of buyers by making the home accessible to those who don’t qualify for a traditional mortgage.
For buyers, this type of loan can be easier to qualify for and more flexible, helping them purchase a home that otherwise may be unattainable.
The Risks Of Wraparound Mortgages
While a wraparound mortgage can benefit both parties, there are risks that buyers and sellers should consider before proceeding with this type of transaction.
It’s wise for both parties to work with an experienced real estate attorney, who can provide assistance through the process and reduce the risk for everyone involved.
As stated before, the original mortgage continues to be the primary loan. The wraparound mortgage is a junior lien. That means if the seller stops making payments and goes into default on the existing mortgage, the original lender can put the mortgaged property into foreclosure and take it away from the new buyer, even if the buyer has stayed current on their payments to the seller.
Buyers can help prevent this risk by making their payments directly to the original lender, as long as their loan terms allow it.
First, there’s the legal risk. If the seller still has an existing mortgage, especially one that’s still relatively high, the original lender must agree to this secondary loan.
Most lenders require the loan to be paid in full once the home is sold and changes ownership. This would prevent the wraparound mortgage from even happening. Before negotiating the terms of the loan or sale, sellers must review their original loan documents to make sure they’re even able to complete this type of real estate transaction.
Once they’re sure they can go forward with a wraparound mortgage, they bear full responsibility for making sure the existing mortgage is paid. If the buyer stops making payments to them, the seller must use their own money to continue making the original mortgage payment.
Alternatives To Wraparound Loans
If you’re a buyer who’s having trouble qualifying for a conventional loan or a seller having trouble finding buyers who qualify, there may be other types of mortgage loans that can help.
FHA loans from the Federal Housing Administration (FHA) can be a great option for qualified home buyers who have lower credit scores or not much cash to close, as these loans have lower down payment and credit score requirements compared to other loans and often allow closing costs to be rolled into the loan.
VA loans for qualified active military or veterans often help buyers who don’t have the money for a down payment since these loans are one of the few that don’t have a down payment requirement. These loans from the Department of Veterans Affairs (VA) also usually have lower interest rates and don’t require private mortgage insurance (PMI).
USDA loans are from the U.S. Department of Agriculture (USDA) and make purchasing a home in a qualified rural area more affordable by not requiring a down payment. Compared to a conventional loan, this loan option usually comes with a lower interest rate and lower-cost PMI, which you can roll into your loan amount.
The Bottom Line: Wraparound Mortgages May Not Be Worth The Risk
In a wraparound mortgage situation, the buyer gets their mortgage from the seller, who wraps it into their existing mortgage on the home. The buyer becomes the owner of the home and makes their mortgage payment, with interest, to the seller. The seller uses that payment to pay their existing mortgage to the original lender.
Depending on the terms of the loan, the seller can make a profit from the difference in the two payments, the one to them and the one to their lender. This is typically done by the seller charging more interest on the wraparound mortgage than the interest charged on the original mortgage.
This loan can be beneficial for both parties but comes with several risks. To mitigate those, the buyer and seller should work with an experienced real estate attorney.
Most homes are purchased through more traditional lending options. If you’re in the market for a new house and ready to secure a mortgage with less risk from a reputable lender, take action and start your mortgage application with Rocket Mortgage®.
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