A wrap-around loan is a unique tool in the world of [real estate] deals and owner-financing. This loan option incorporates the seller’s existing mortgage and adds an amount to encompass the total purchase price to be paid to the seller over an agreed period.
Key Highlights
- Wrap-around loans are utilized in owner-financing; the seller maintains an existing mortgage, which is partially repaid by the new buyer.
- Rather than getting a conventional bank mortgage, the buyer arranges a mortgage with the seller to repay the existing loan.
- This form of loan can be risky, as the seller takes on default risk for both loans involved.
Grasping Wrap-Around Loans
Wrap-around loans shine in situations necessitating seller-financed deals. This form of financing takes a seller’s current mortgage and incorporates it into the loan terms.
Sellers financing typically involves the buyer making the principal payments directly to the seller. While attractive, these deals carry substantial risk for the seller and often necessitate hefty down payments. Generally rooted in a promissory note, these agreements don’t demand upfront principal payments, with the buyer making installment payments (including principal and interest) directly to the seller.
For the seller, these deals are risky, requiring vigilance for alienation clauses in existing mortgages which might prompt a full repayment in case of ownership transfer. Such clauses can significantly hinder the feasibility of wrap-around loan arrangements.
How Wrap-Around Loans Operate
Expanding on the owner-financing model, wrap-around loans incorporate an unresolved balance from the property’s first mortgage. The loan amount integrates the remaining balance of the seller’s mortgage and additional funds to cover the purchase price.
Here, the seller earns interest based on the rate stipulated in the existing mortgage and negotiates an incremental balance, often aiming for the highest possible rate to earn from both interest spreads and principal payments.
Example of a Wrap-Around Loan in Action
Consider a scenario where Joyce owes $80,000 on her home mortgage at a 4% fixed rate. She sells her home to Brian for $120,000. Brian puts down 10% and borrows the remaining $108,000 at a 7% interest rate.
Here’s the breakdown:
- Joyce earns 7% return on $28,000 (the difference between $108,000 and her $80,000 mortgage).
- Additionally, Joyce earns an extra 3% (difference between 7% and 4%) on the $80,000 mortgage balance she still owes.
Such frameworks provide sellers with an opportunity to finance a sale and earn substantial returns on the financing terms.
Related Terms: Mortgage, Owner-Financing, Seller-Financing, Promissory Note, Alienation Clause.
References
- National Association of Realtors. “Seller Financing”.
Get ready to put your knowledge to the test with this intriguing quiz!
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## What is a wrap-around loan?
- [ ] A loan used primarily for home improvements
- [ ] A loan taken against another existing loan
- [ ] A loan with a fixed interest rate
- [x] A loan that includes the remaining balance of the seller’s existing mortgage, plus an additional amount
## Which of the following best describes the primary feature of a wrap-around loan?
- [ ] It replaces the existing mortgage entirely
- [ ] It entails paying off the buyer's existing loans
- [x] It incorporates the seller’s outstanding mortgage with new financing for the buyer
- [ ] It is used only for high-risk investments
## In what scenario is a wrap-around loan typically used?
- [ ] When the buyer has sufficient funds to buy the property upfront
- [ ] When the property is brand new
- [x] When a buyer cannot immediately qualify for a conventional mortgage
- [ ] When interest rates are very low
## Who typically benefits the most from a wrap-around loan?
- [ ] Both the buyer and the seller
- [ ] The real estate agent
- [ ] Only the seller
- [x] Both the seller and the buyer, with potential financial advantage
## What is the risk primarily associated with a wrap-around loan for the buyer?
- [ ] Higher interest rates compared to conventional loans
- [x] Seller's failure to make payments on the underlying mortgage
- [ ] Difficulty in obtaining a large loan amount
- [ ] Lack of tax benefits associated with mortgage interest
## Why might a seller be willing to offer a wrap-around loan?
- [ ] To close the deal slowly
- [x] To facilitate a quicker purchase by the buyer
- [ ] For tax evasion purposes
- [ ] To engage in complicated financial arrangements
## What responsibility does the seller hold in a wrap-around loan?
- [ ] Monitoring buyer's credit score
- [x] Continuing to make payments on the original mortgage
- [ ] Act as a real estate advisor to the buyer
- [ ] Utilize the loan amount for property improvements
## When does the buyer usually make payments in a wrap-around loan setup?
- [x] To the seller who then makes payments on the original mortgage
- [ ] Directly to the original lender
- [ ] To an escrow account held by a financial institution
- [ ] To a real estate agent
## How can a wrap-around loan benefit the seller in terms of income?
- [ ] By providing access to financial grants
- [x] By potentially receiving higher interest payments than on their original mortgage
- [ ] By reducing the property taxes
- [ ] By minimizing monthly payment amounts
## Which of the following could be a disadvantage of a wrap-around loan for the seller?
- [ ] The property values significantly increase
- [x] Risk of buyer defaulting on the new loan but the seller remains responsible for the original mortgage
- [ ] Lesser gains in real estate market
- [ ] Lower interagency cooperation
