A wraparound mortgage is a type of creative financing that allows buyers and sellers to strike win-win deals, particularly useful when existing mortgages cannot be paid off immediately. This type of junior loan wraps or includes the current mortgage note on the property and adds extra funds to cover the new purchase price.
Key Takeaways
- Wraparound Mortgages Simplified: These are junior loans that encompass the current note on the property along with an additional loan that covers the property’s purchase price.
- Secondary Financing: Wraparounds are a form of secondary and seller financing, with the seller issuing a secured promissory note—a legal IOU for the amount due.
- Profit Margins: The arrangement lets the lender (often the seller) collect mortgage payments from the borrower, which pays off the original note and provides a profit margin.
- When They Are Useful: Often arise when the existing primary mortgage cannot be paid off immediately.
How a Wraparound Mortgage Works
Wraparound mortgages serve as an innovative avenue for refinancing a property or financing its purchase, especially when existing mortgage obligations remain unsettled. The total loan amount in a wraparound mortgage wraps the remaining balance of the previous mortgage plus additional new funds. Borrowers make payments on a larger new wraparound loan, from which lenders use the payments to settle the original mortgage, while also earning an interest margin for themselves.
The transfer of property title may occur immediately to the new owner, or the seller might retain this title until full loan repayment, contingent on the loan agreement terms.
A defining feature of a wraparound mortgage is that it’s a form of seller financing—no conventional bank mortgages are involved as the seller essentially ‘becomes the bank.’ It’s important to note that a wraparound mortgage typically sits as a junior mortgage. Hence, if default occurs, senior claims will take precedence and must be settled first during asset liquidation.
Wraparound Mortgage vs. Second Mortgage
Both wraparound mortgages and second mortgages are forms of seller financing but differ notably. While a second mortgage is subordinate and made when the original mortgage is active, wraparound mortgages ‘wrap’ the existing loan balance into the new mortgage.
In a second mortgage, you pay interest separately on both the original and second loan amounts. With a wraparound, payments integrate covering the entire outstanding debt and the additional funds, usually leading to an all-inclusive interest structure.
Example of a Wraparound Mortgage
Consider Mr. Smith, who has an existing home mortgage with a $50,000 balance at a 4% interest rate. He sells this house to Mrs. Jones for $80,000, and although Mrs. Jones has no direct banking financing, she gets a mortgage directly from Mr. Smith or another lender at 6%. Mrs. Jones makes periodic mortgage payments to Mr. Smith, who then uses these payments to continue servicing his original, lower-rate mortgage.
Through this mechanism, Mr. Smith profits both from the difference of the sale price over the owed balance and from the interest rate spread. The property officially transfers to Mrs. Jones based on the loan agreement. However, if she defaults, senior lienholders or Mr. Smith could foreclose and seize the property back.
Wraparound mortgages offer effective solutions in niche financial scenarios, promoting flexibility for both sellers and buyers in dynamic real estate markets.
Related Terms: promissory note, refinancing, junior mortgage, seller financing, second mortgage, foreclosure.
References
- Washington and Lee Law Review. “Unwrapping the Wraparound Mortgage Foreclosure Process”, Pages 1025-1027.
- National Archives, Code of Federal Regulations. “Title 26 § 15a.453-1 Installment Method Reporting for Sales of Real Property and Casual Sales of Personal Property”.
- Consumer Financial Protection Bureau. “What Is a Second Mortgage Loan or ‘Junior-Lien’?”
