What is a wraparound mortgage?
A wraparound mortgage is a type of financing for a seller in which the seller holds the original mortgage in the home and acts as a lender for the buyer.
While that’s far from traditional loans, wraparound mortgages can be an opportunity for home buyers struggling to get a mortgage, for sellers struggling to sell their homes or pay their mortgage.
To extend a wraparound mortgage, the seller must have a mortgage that is expected.
How do wraparound mortgages work?
With wraparound mortgages, the buyer’s new loan “enves” the seller’s existing loan on the property. The buyer pays the seller monthly. Sellers pay their mortgage lenders.
Wrap Around Loans often have higher interest rates than the original mortgage. As a result, buyer’s monthly payments to sellers often result in sellers becoming larger to lenders, allowing sellers to make a profit.
Both the buyer and the seller must agree to a wraparound mortgage, and the seller must obtain permission from the lender.
After the terms are in place and the buyer signs the promissory note, the seller may immediately transfer the title of the house to the buyer, or, once the loan is paid back, it may transfer it to the buyer. Once the title is transferred, the buyer is considered the property owner.
A wraparound mortgage is in the junior or second lien position. This means that if the buyer cannot or does not make the payment, the original mortgage lender, not the home seller, will be repaid first from the proceeds from the foreclosure sale. The seller will only collect the loss after the lender has regained the money.
Examples of wraparound mortgages
Suppose the seller has a mortgage balance of $100,000 in a home worth $200,000. Sellers are paying off their loans on a 30-year mortgage at a 5% rate.
Sellers find interested buyers who are unable to qualify for traditional fundraising, offer buyers a $150,000 wraparound loan and a $50,000 down payment at a 7% interest rate.
Sellers will quickly pocket a down payment of $50,000 and a $150,000 loan balance for borrowers to make payments. He or she will also receive the difference between the new interest rate and the original interest rate.
A wraparound mortgage does not need to be larger than the original mortgage. Buyers and sellers may agree to a loan that covers only the current principal.
Wrap Around Mortgage Benefits
A wraparound mortgage can have advantages for buyers and home sellers.
Benefits for buyers
- Easy to get. “If a buyer doesn’t qualify for a mortgage product with a lender, a wraparound mortgage is a good idea,” says Benjamin Schandelson, mortgage originator and head of marketing at MJS Financial LLC in Boca Raton, Florida.
- Small loans. Buyers may be able to borrow less or get lower interest rates than they would if they were applying for their own loan.
- Simpler and cheaper transactions. Buyers may not have to wait for the lender’s long underwriting process and may not have to pay many closure fees.
Seller’s Benefits
- Probability of profit. In addition to appreciating home prices, sellers can pocket the differences between remaining mortgage balances and wraparound mortgages, as well as the differences between original interest rates and buyer rates.
- Sales strategy. Offering a wraparound mortgage may increase interest in your home and attract buyers who may not normally be able to afford it – especially if you are struggling to sell.
Wrap Around Mortgage Risk
A mortgage is not perfect. Both buyers and sellers face the risk of several wraparound mortgages.
Buyer risk
- Unreliable seller. “The biggest risk is that sellers default on their original mortgages and can place the property where the buyer lives in foreclosure,” says Chandelson. If the seller defaults on his or her loan, the lender can seize the home, even if your payment records are clean. You also need to believe that a mortgage was intended in the first place. If the seller does not obtain wraparound permission, the lender may also foreclose or request an immediate payment of the loan balance.
- More expensive terms. The interest that sellers are charging can exceed traditional mortgage fees.
Seller’s risk
- document. Setting up a wraparound mortgage means sending statements and invoices, tracking payments, maintaining records, and taking into account the income on your tax return. If you don’t submit properly, the IRS won’t be happy.
- Unreliable buyers. If the buyer hasn’t paid, you’re still hooking your lender. “This means you have to get out of your pocket or miss a payment. “You may also need to take legal action against the buyer to not make a payment.
Is a wraparound mortgage perfect for you?
Wrap Around Mortgages are a creative way for buyers and sellers to make a deal come true, especially in today’s challenging real estate environment. If you are a future buyer and are struggling to qualify for a mortgage, a wraparound mortgage can take you home. And as sellers’ markets soften over the past few years, wraparound mortgages can become a way to offload properties that are difficult to sell.
However, there are risks on both sides. Before moving forward with a wraparound mortgage, it is wise to consult with a real estate attorney who can advise on the risks and ensure that an agreement is properly formulated to protect all parties. For example, a buyer might want to add a clause that allows lenders to create a portion of their direct payment. Sellers may wish the buyer to put a certain total in escrow as a cushion if the buyer is late or behind on payment.
Wrap Around Mortgage Alternatives
They can help buyers in under-credit or high-paying environments, but wraparound mortgages are not the only option. Let’s consider these alternatives.
- Government-supported loans. These mortgages offer low down payment requirements and are available to borrowers who do not have a good credit score. FHA loans have the lowest limit. USDA and VA loans offer generous terms, but you can only qualify if you are purchasing in a qualified rural area (USDA), or in the military (VA), or are in the affiliated company.
- HFA loan. HFA loans are available only through state housing finance institutions. To qualify, you may need to buy in a specific location or select a home within certain price restrictions.
- Traditional 97 loans. Available through government-sponsored entity Fannie May, this is a traditional mortgage with a 3% down payment requirement.
Sellers may also consider alternatives such as:
- rental. Using a home as an investment property can potentially bring great benefits at similar risk levels. You can provide long-term leases to your tenants and set up rental agreements.
- Renovation. If you need more space or want a better home, consider trying to expand or renovate your location instead. Some strategic remodeling can make your home more valuable in the future.
