Definition
A wraparound mortgage, also known as a wrap loan, is a type of secondary financing where a new mortgage is created to include the original mortgage amount plus the amount for a new loan. The lender on the new loan “wraps” or combines the old loan with a new loan at an interest rate somewhere between the original loan rate and the rate on the existing mortgage. This allows the borrower to make one single payment to a single lender, typically at a savings.
Key Takeaways
- A wraparound mortgage is a form of secondary financing for the purchase of real property. The seller extends a credit to the buyer for the mortgage and collects payments, while continuing to pay the original loan.
- This form of mortgage can be beneficial for sellers as it could potentially enable them to sell a property more quickly and possibly at a higher price, due to offering a financing option to buyers who might not qualify for a traditional mortgage.
- Wraparound mortgages come with risk for both parties involved. For the buyer, the risk lies in the fact that the original mortgage still stands in the seller’s name, so if the seller fails to make payments, the property could be foreclosed upon. For the seller, the risk lies in the fact that most mortgages have a due-on-sale clause, which means the full loan could be called due upon selling via a wraparound agreement.
Importance
A wraparound mortgage is important in the finance sector as it provides an innovative strategy for both the borrower and the lender, especially in a challenging real estate market. This type of loan allows the borrower to secure new financing while still maintaining the original mortgage.
The lender creates a new mortgage that encompasses the balance due on the old mortgage, plus the amount for the new loan. The borrower then makes payments to the lender defined by the wraparound loan terms, and that lender continues to pay the original mortgage.
This can be beneficial to a borrower who might otherwise struggle to get traditional financing. Moreover, the arrangement often enables the lender to earn a higher rate on the wrapped mortgage than the original mortgage, leading to a greater return on investment.
Explanation
The primary purpose of a wraparound mortgage, a type of creative financing, is to enable property owners to sell their property even if they still have a substantial existing mortgage balance on it. This innovative form of financing essentially wraps the old mortgage with the new one, where the new lender (usually the seller) pays off the old loan with the repayment of the new one.
This is particularly useful in situations where the interest rates on the existing mortgage are lower than the prevailing rates, enabling the seller to offer competitive rates and attract potential buyers. Moreover, wraparound mortgages can be a win-win scenario for both parties involved in a real estate transaction, particularly in a seller’s market or when traditional financing options may not be readily accessible to the buyer.
For sellers, it allows them to sell the property quicker and potentially with a higher selling price due to the provision of seller financing. For buyers, especially those with less than stellar credit, it gives them an opportunity to purchase a home without needing to qualify for a traditional mortgage loan.
However, both parties should thoroughly understand the terms of the mortgage and any potential risks before proceeding.
Examples of Wraparound Mortgage
**Residential Property Investment:** John, a small real estate investor, wants to buy a residential property listed for $300,However, he doesn’t have the funds upfront to purchase it. The current homeowner, Sally, still has an existing mortgage of $200,000 on the property. Instead of getting a loan from a traditional lender, John proposes a wraparound mortgage where he pays Sally a down payment of $50,000, and makes monthly payments covering both the existing mortgage and the additional $100,
This way, Sally gets a stream of income while John becomes the owner of the property without needing a full-priced loan from a bank.**Commercial Real Estate Deal:** A business owner, Mike, approaches a property holder, Tom, to acquire a commercial property to expand his company. The property in question still has $350,000 left on its mortgage. A wraparound mortgage deal is arranged where Mike provides a down payment and agrees to cover the remaining mortgage plus an extra $150,000 for the total acquiring price. The agreed interest is higher than Tom’s existing interest rate, allowing Tom to earn some passive income.
**Distressed Homeowner Scenario:** Lisa, a homeowner, is facing financial difficulties and struggling to make payments on her mortgage of $150,Instead of allowing the bank to foreclose, she agrees to a wraparound mortgage with Rachel, a real estate investor. Rachel pays Lisa $50,000 upfront and starts making monthly payments that cover Lisa’s current mortgage payment plus interest on the $50,
Rachel then leases the property to another person and collects the rent, intending to eventually sell the property at a profit.
Frequently Asked Questions about Wraparound Mortgage
What is a wraparound mortgage?
A wraparound mortgage refers to a type of secondary financing, which a homeowner can use to sell their home. The seller provides enough financing to the buyer to cover the existing mortgage in addition to the difference between the selling price and the mortgage amount.
How does a wraparound mortgage work?
In a wraparound mortgage, the buyer pays the seller, and the seller continues to pay their existing mortgage. The payments made by the buyer are then applied to the original mortgage, and the excess becomes profit for the seller.
What are the benefits of a wraparound mortgage?
A wraparound mortgage can benefit a seller by allowing them to sell their property and possibly earning interest on the wraparound loan. For buyers, a wraparound may be an option if traditional financing is not available.
What are the risks of a wraparound mortgage?
A major risk with a wraparound mortgage is that if the seller fails to make the payments on the original mortgage, the bank can foreclose on the house, even though the buyer has been making the required payments.
Is a wraparound mortgage legal?
Yes, a wraparound mortgage is legal, but it must comply with any due-on-sale clauses and local laws. It is highly recommended to involve a real estate lawyer when dealing with such complex transactions.
Related Entrepreneurship Terms
- Equity
- Junior Mortgage
- Existing Lien
- Payment Default
- Refinance
Sources for More Information
- Investopedia: Provides definitions and detailed explanations for many financial terms, including Wraparound Mortgage.
- Bankrate: Offers expert advice and related terms on a diverse range of financial topics.
- The Balance: A personal finance website where you can find detailed and easy-to-understand articles on many subjects, including Wraparound Mortgage.
- The Motley Fool: Offers insights on stocks, investing, personal finance, and news.
