Definition
A wrap-around loan is a type of mortgage loan that consolidates an existing loan into a new loan with a larger amount, essentially ‘wrapping around’ the initial loan. The new lender now makes payments on the original mortgage and provides the borrower with a new, larger loan, often at a higher interest rate. This type of loan is commonly used in real estate transactions as a means of refinancing.
Phonetic
The phonetics of the keyword “Wrap-Around Loan” is /ˈræp əˌraʊnd ˈloʊn/.
Key Takeaways
- A Wrap-Around Loan is a form of secondary financing for the purchase of property. It occurs when a lender provides a new loan to the borrower while keeping the existing mortgage intact.
- This type of loan may benefit both buyer and seller. The borrower can obtain financing with lower credit requirements, while the seller can earn a potential higher rate of interest.
- Despite its benefits, Wrap-Around Loans can be risky. The original lender may call the loan due if the loan contract contains a due-on-sale clause. Additionally, the buyer pays the mortgage payments to the seller, who then pays the original mortgage. If the seller fails to make these original mortgage payments, the property may be foreclosed causing loss for the buyer.
Importance
A Wrap-Around Loan is an important financial instrument especially in real estate financing. This loan allows the borrower to secure additional financing while maintaining the original loan. Lenders normally offer it at an interest rate above the primary loan’s rate resulting in greater profits for the lender. The original loan is wrapped by the additional funding received, hence the term wrap-around loan. It is important because it lets borrowers acquire more financing without having to refinance their original loan. Additionally, it provides potential advantages such as a simpler application process and more favorable loan terms for borrowers who might otherwise struggle to obtain traditional financing.
Explanation
The wrap-around loan serves as an advantageous financing structure primarily used in real estate transactions, enabling the buyer to access funds while enabling the seller to maintain an income stream. Primarily known for its functionality in seller financing, a wrap-around loan not only facilitates the purchase of the property for the buyer but also allows the seller to earn interest on the loan, which can often be a potential income higher than traditional investment methods.This type of loan solves various financial issues that both the buyer and the seller might face. For example, if a buyer cannot qualify for a traditional mortgage or if the interest rates are too high, the wrap-around loan presents an alternative financing option, ensuring that the real estate transaction can proceed despite these barriers. On the other hand, for the seller, particularly one with a considerable property portfolio and low mortgage rates, wrap-around loans provide an opportunity to dispose of their properties while capitalizing on high market interest rates. Consequently, the established income stream from the interest payments supplements their revenue, making this a beneficial arrangement for both parties involved.
Examples
1. Real Estate Investment:Let’s assume a property investor purchases a property worth $150,000 with an existing mortgage of $100,000 at an interest rate of 5%. They can use a wrap-around loan to borrow the full purchase price or $150,000. The wrap-around loan will have a higher rate, say 6%. The investor then pays 5% to continue the original loan and pockets the 1% difference, while the seller gets the agreed selling price.2. Home Renovation:A homeowner who has an existing mortgage on their house but needs funds for renovation can opt for a wrap-around loan. For example, if the existing mortgage is $250,000, and the homeowner needs an additional $50,000 for renovations, they can take a wrap-around loan for $300,000. This way, they continue to pay their original mortgage while incorporating the additional funds needed.3. Small Business Loan:A small business owner has an existing business loan but needs additional capital to finance a new project. He owes $200,000 on the original loan, but needs $100,000 more for the project. The lender provides a wrap-around loan for $300,000. The business owner now makes payments on this new loan, with the lender paying off the original loan and the excess goes towards the new project.
Frequently Asked Questions(FAQ)
What is a Wrap-Around Loan?
A wrap-around loan is a type of mortgage loan where a lender assumes responsibility for an existing mortgage. In most instances, the lender is the seller of the home, and this type of loan can benefit both parties.
How does a Wrap-Around Loan work?
The borrower makes payments to the lender who, in turn, makes payments on the original loan. The difference in payments from the original loan to the new loan taken is the income for the seller of the property.
Is a Wrap-Around Loan beneficial for the borrower?
Yes, a wrap-around loan is often beneficial for a borrower, especially if they are unable to secure traditional financing. This could be due to poor credit history or an unsteady job situation.
Is a Wrap-Around Loan risky for the seller/lender?
Yes, there is risk involved for the seller. If the buyer defaults on the wrap-around loan, the seller will have to repay the original mortgage.
Are there restrictions to Wrap-Around Loans?
Yes, some mortgages have a due-on-sale clause, which prohibits the wrapping of loans. The loan must be paid off when the property is sold.
What are the advantages of a Wrap-Around Loan?
Advantages for sellers include earning interest on the loan balance and being able to sell the property faster. Borrowers can benefit from easier qualification requirements and potentially lower interest rates.
What are the disadvantages of a Wrap-Around Loan?
The main disadvantage for the seller is the risk that the buyer may default on their payments. For the buyer, it is that the seller may not make the payments on the first mortgage with the funds received from the wrap-around loan or the original lender may have a loan contract clause requiring full payment if the deed changes hands.
Can a Wrap-Around Loan be used with any type of property?
Yes, a Wrap-Around Loan can be used with any type of property, although it’s typically used with residential properties.
Are Wrap-Around Loans common?
They are less common than traditional mortgages but are often utilized in situations where the buyer cannot qualify for a loan from a traditional lender. They are most common in seller-financed transactions.
Related Finance Terms
- Mortgage
- Second Mortgage
- Principal
- Interest Rate
- Amortization
Sources for More Information
