A wraparound mortgage allows buyers to qualify for a seller-financed mortgage. Sellers may choose to use a wrap-around mortgage to open the buyer pool. Both buyers and sellers face significant risks with this type of financing. But it also comes with some major advantages. Read on for pros, cons and frequently asked questions to understand whether this mortgage product will work for you.
How Does a Wraparound Mortgage Work?
A wraparound mortgage, also known as an all-inclusive mortgage or overriding mortgage, is a type of financing arrangement that allows a buyer to purchase a property while assuming the existing mortgage and obtaining additional financing from the seller. This type of mortgage is helpful for buyers who can't qualify for a traditional mortgage or a U.S. Department of Agriculture (USDA) loan.
As the name implies, a mortgage "wraps" around the seller's existing mortgage. A wraparound mortgage can also be a secondary mortgage financing. With wraparound loans, the buyer makes monthly payments directly to the seller, often at a higher interest rate than the original mortgage. The wraparound mortgage definition is a mortgage in which the seller gives financing and wraps the new mortgage around their existing mortgage.
Who Qualifies for a Wraparound Mortgage?
Anyone can qualify for a wraparound loan. However, it is most commonly used by buyers who can't qualify for other types of mortgages.
Are There Any Risks Associated with a Wraparound Mortgage?
Both buyers and sellers face risks with this type of mortgage. For the buyer, it's a way to qualify for financing more easily, but they risk the seller not paying off the mortgage. This could lead to the original lender foreclosing on the house. Therefore, some buyers will include a clause that they make part of the payments to the lender directly.
For sellers, the risk of a wraparound mortgage is that the buyer defaults. They may have a clause stating they can foreclose on the buyer, but the hassle might not be worth the risk.
Who Can Benefit from a Wraparound Mortgage?
Anyone can benefit from a wraparound loan. Sellers with a home that isn't selling can use this type of mortgage to open the property to a larger market. Buyers who don't qualify for a traditional mortgage can use a wraparound mortgage to purchase a home.
How Can Borrowers Protect Themselves when Using a Wraparound Mortgage?
Borrowers can protect themselves when using a wraparound mortgage by including a clause in the agreement that allows them to make a portion of their monthly payment directly to the original mortgage lender.
Wrap Around Mortgage Example
Suppose Andrea wants to sell her house for $300,000. She has an existing mortgage with $50,000 remaining at 4% interest. Sam wants to buy the house and agrees on the price of $300,000. Because Sam can't qualify for a traditional mortgage, Andrea and Sam agree to a wraparound loan with a $40,000 down payment and a 7% interest rate.
With the difference in interest, Andrea makes a profit while paying off the rest of her mortgage. She'll make 7% interest on $250,000 and the 3% difference on the $50,000 she still owes.
Things to Consider with a Wraparound Mortgage
Whether you're considering this mortgage product as a buyer or a seller, here are points to consider:
Payment Structure
With a wraparound loan payment structure, the buyer will pay the seller a monthly mortgage payment, usually higher than the seller's current mortgage interest rate by 2% to 3%. The seller will continue to make their mortgage payment to the original lender. This presents additional risks for both the buyer and the seller.
Interest Rate
Interest rates are typically higher for wraparound mortgages. For buyers, this could mean you'll pay significantly more over the life of the loan. For sellers, the additional interest profit can justify choosing a wraparound mortgage.
Terms and Conditions
Understand the terms and conditions of the existing mortgage and negotiate the terms and conditions of the wrap mortgage. Some mortgages don't allow wraparound mortgages, so sellers should speak with their lender about terms and conditions.
In addition, have a lawyer review the terms and conditions from the perspective of both buyer and seller to ensure both parties are protected in case of default on either the wraparound mortgage or the original loan.
Evaluating the Financial Feasibility of the Property
Sellers should perform the same feasibility analysis that traditional lenders would perform, including looking at the buyer's debt-to-income ratio. It's essential for both parties to understand the property's assessed value and current market conditions before agreeing on a price and terms.
Potential Risks
Being the lender in a wrap mortgage comes with significant liability. Work to identify and mitigate the risks of a wraparound mortgage before proceeding, including clauses in case of late payments or default.
Advantages of Wraparound Mortgage
A wrap-around mortgage has significant benefits for both the buyer and the seller. For buyers, wraparound mortgages require less paperwork and are easier to get than a traditional mortgage. The flexible arrangement is convenient for buyers, even with potentially higher interest rates.
For sellers, the benefits of a wraparound loan include a wider buyer pool and additional income from interest payments.
Disadvantages of Wraparound Mortgage
Wraparound loans come with possible risks for both buyers and sellers. Potential risks include seller default, buyer default and negative equity.
In seller default, the seller receives the buyer's payment but doesn't use it to pay off their remaining mortgage balance. The bank will foreclose on the property, and the buyer could be forced to move. With buyer default, the seller would have to foreclose on the buyer, a complicated and potentially lengthy process.
With negative equity, a risk for buyers, the real estate value could fall below the outstanding balance on the mortgage used to purchase that property. That can happen in volatile markets or when the purchase price is higher than the property's assessed value.
Wraparound Mortgage vs. Traditional Mortgage
Wraparound and traditional mortgages offer loans to purchase a home or real estate at a set (or variable) interest rate. Traditional lenders require buyers to meet set criteria, including proof of income and employment, credit score requirements and a debt-to-income ratio of 43% or less.
Wraparound loans are easier to qualify for and don't require the same documentation, making them a desirable option for some buyers.
Should You Get a Wrap Mortgage?
Wraparound mortgages aren't for everyone. They present additional risks for both buyers and sellers. But for many, the benefits outweigh the possible risks. If you're having difficulty selling your property or qualifying for a traditional mortgage, a wrap mortgage offers a path to a sale or homeownership. If you decide to go for it as either a buyer or seller, engage a lawyer to review all documentation and speak to the existing lender to protect your interests.
Frequently Asked Questions
Can a wraparound mortgage be refinanced or paid off early?
Terms depend on the specific mortgage, although many sellers may allow the buyer to pay off the wraparound mortgage early if they are able to secure another mortgage.
How are wraparound mortgages structured?
Wraparound mortgages are a type of seller financing. The seller uses the buyer’s mortgage payments to pay off their existing mortgage.
Can wraparound mortgages be used for commercial properties?
Yes, a wraparound mortgage can be used to purchase a commercial property. In that case, you will take out the mortgage with the commercial property seller as the lender.