Wrap Around Mortgage: What it is and How it Works

Wrap Around Mortgage: What it is and How it Works

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Wrap around mortgages are home loans issued by a home seller to a homebuyer. Under a wrap around mortgage agreement, instead of paying off their existing mortgage, the home seller keeps their home loan in place, while the buyer’s new mortgage “wraps around” the existing home loan. Generally, wrap around mortgage loans make sense when home sellers cannot find buyers who qualify for conventional mortgages. Sellers struggling to sell their homes, and buyers who have trouble finding reasonable rates from traditional lenders may find them useful.

What is a Wrap Around Mortgage?

Wrap around mortgages are also known as “seller carry-back financing” or “a wrap mortgage.” In a wrap around mortgage agreement, the buyer obtains a mortgage and title to the house from the seller rather than a bank.

Simultaneously, the seller keeps their existing home loan outstanding and structures the new mortgage around their existing home loan. This results in a cycle where the buyer makes monthly payments to the seller and the seller turns around and uses those proceeds to make payments on the old mortgage.

Even though the seller continues to pay their old mortgage, they no longer own the house. As soon as the buyer and seller sign the new wrap around mortgage agreement, the title and home deed pass to the buyer. This results in shared risk for both the buyer and seller.

Unlike most purchase mortgages, the wrap around mortgage is a second-position mortgage (also known as a junior lien). That means that the seller’s mortgage lender can still foreclose on the house if there is a default on the original mortgage.

To avoid foreclosure, sellers use the payments from the second position mortgage to pay their bank mortgage. Typically, the wrap around mortgage will have an interest rate that is higher than the primary mortgage. This allows the seller to earn a “spread,” or profit, on the new loan.

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Wrap around mortgages often contain loan provisions that aren’t in traditional mortgage financing. For example, the wrap around mortgage may include a balloon payment clause at the end of three to five years. This provision protects the seller from holding onto a wrap around mortgage indefinitely and allows the borrower time to build their credit and obtain a traditional mortgage loan.

How Does a Wrap Around Mortgage Work?

A wrap around mortgage is a three-way agreement between the buyer, the seller and the original lender on the home. Both the buyer and seller are closely involved in the success of a wrap around agreement, as the buyer must make timely payments to the seller and the seller must make timely payments to the original lender. The original lender must approve the agreement so that it doesn’t expect to receive the full loan amount when the property title is transferred.

Example of a Wrap Around Mortgage

A seller wishes to sell her house for $200,000. She still owes $25,000 on her mortgage, which has a fixed interest rate of 3.5%. She consults her lender, who confirms that her existing loan documents and local laws allow her to establish a wrap around mortgage agreement.

Her buyer agrees to the $200,000 price but cannot find financing at any standard mortgage lender. Instead, the buyer puts $10,000 down and borrows $190,000 in a wrap around mortgage from the seller at a 4.9% interest rate.

When the buyer and seller sign the mortgage, the seller transfers title on the home to the buyer. Afterward, the buyer pays the seller each month, which allows the seller to turn around and pay her lender. The seller then pockets the difference between the buyer’s payment on the wrap around mortgage and the amount she uses to pay the original mortgage.

Risks of a Wrap Around Mortgage Agreement

One risk that can scuttle a wrap around agreement before it even begins is the lender’s right to exercise a “due on sale” provision. If this clause is in the original loan documents, the seller’s lender can call in the full balance of the original mortgage as soon as the property sells. If the seller cannot pay the mortgage balance when it is called, the lender can foreclose, leaving both buyer and seller empty-handed.

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Only assumable mortgage loans are eligible for wraparound agreements. Currently, conventional mortgages issued under Fannie Mae and Freddie Mac guidelines require lenders to accelerate the debt on loans that contain due-on-sale provisions. Regardless, buyers and sellers should consult a real estate attorney to understand the risks of a due-on-sale situation.

Seller Risks Under a Wrap Around Mortgage Contract

The more equity that a seller has in a home, the riskier it becomes to issue a wraparound mortgage. For example, if the buyer defaults on the wraparound mortgage, the seller still has to pay the primary mortgage to the bank. On top of that, the seller must pay legal fees to foreclose on the buyer. If the seller cannot pay for these expenses, they risk having their lender foreclose on them.

Buyer Risks Under a Wrap Around Mortgage Contract

The biggest risk for most buyers is that the seller defaults on their mortgage. Buyers can mitigate this risk by drafting the loan documents in a way that gives the buyer the right to make payments directly to the seller’s lender. These payments can then be credited against the payments due to the borrower. Buyers should consult with a real estate attorney to confirm that their wraparound mortgage documents are written in a way to confer this protection.

How to Do a Wrap Around Mortgage

Borrowers who want a wrap around mortgage have to find sellers who are willing to finance a wrap around mortgage. Sellers who have trouble selling their homes or who are facing default may be more willing to issue this type of loan.

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Institutional lenders don’t issue wraparound mortgages directly, but some may be willing to accommodate if the original mortgage is assumable. Make sure you involve a real estate attorney who can confirm that your original loan documents allow for a wrap, and to ensure that the wrap around agreement is carefully drafted.

Alternatives to Wrap Around Mortgages

A wrap around mortgage may be too risky for most sellers and buyers. Here are a few alternatives that people may want to consider:

Traditional Mortgage Financing

People with poor credit profiles can still qualify for a mortgage through a variety of government-sponsored financing programs. FHA loans allow for credit scores as low as 580 and down payments of as low as 3.5%. Additionally, many buyers can qualify for 0% down USDA or VA mortgages.

Certain mortgage brokers and warehouse lenders may even be able to net you a stated-income mortgage with minimal documentation requirements, which is especially helpful if you’re self-employed or have variable cash flows.

Land Contracts

A land contract is similar to a wrap around mortgage, but differ on when the deed transfer occurs. In a land contract, a buyer makes payments to the home seller until the purchase price is paid in full. Once the land contract is paid off, the buyer gets full ownership of the property. At that point, the seller transfers the deed of ownership to the buyer. Unlike a wrap around mortgage, the buyer has an “equitable title” under a land contract, but does not technically have full ownership to the property.

Seller Issued Second Mortgage

If you’re having trouble getting approved for a large loan amount, a seller could issue a second mortgage to help bridge the gap in financing. After the buyer takes out a first-lien position mortgage with the bank, the seller then issues a second-lien position mortgage to the buyer to cover the remaining balance. The buyer then becomes responsible for making payments to both the bank and the seller.