Definition
A wraparound mortgage is a type of secondary financing for the purchase of a real estate property. The current mortgage is kept in place and a new larger one is created that includes the remaining balance of the existing mortgage along with the new amount. The buyer makes payments to the lender of the new mortgage, who then uses part of these payments to meet the old mortgage.
Phonetic
The phonetics of the keyword: Wraparound Mortgage is /ˈræpəˌraʊnd ˈmɔːɡɪdʒ/.
Key Takeaways
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- A wraparound mortgage incorporates an existing mortgage into a new one. This is often done when a seller has a mortgage on a property, and sells it to a buyer who takes out a new, larger mortgage.
- Payments on a wraparound mortgage are made by the borrower to the lender who then proceeds to pay off the original mortgage. This system gives the lender the capacity to collect interest on the entire amount of the new loan, while still keeping up with payments on the original mortgage.
- A wraparound mortgage can prove beneficial for both the buyer and the seller in a real estate deal. Buyers might be able to secure loan terms more favorable than what’s available through traditional channels, while sellers might be able to sell their property faster and possibly at a higher price.
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Importance
A wraparound mortgage is a crucial concept in finance and real estate as it forms an alternative financing option for buyers who may not qualify for traditional mortgages. This kind of loan encompasses or ‘wraps around’ an existing mortgage while still making the buyer liable for the new debt. Hence, the lender receives the difference between the payments of the first and second loans. This can be beneficial for the seller who may receive a steady income from the interest rate difference between the original mortgage and the wraparound loan. The importance of this term also lies in its convenience to home sellers and real estate investors, giving them more options to sell or buy property with flexible seller financing.
Explanation
A wraparound mortgage, known as a method of refinancing, serves a crucial role in real estate financing, especially when the existing loan carries a lower interest rate than the current market rate. The purpose of this kind of finance tool is to allow the borrower, who may not qualify for a more conventional mortgage or desire a simple loan process, to purchase property without having to secure a new loan. Instead, the seller extends a mortgage to the buyer which wraps around the existing one, often with a higher interest rate to boost their profit.The employment of a wraparound mortgage is specifically advantageous for parties in a seller’s market, where it allows buyers to secure properties quickly and with potential financial flexibility. However, it should be noted that it is used not only for residential transactions but also in commercial real estate transactions. Essentially, it allows a buyer to take possession and gain tax advantages from a property without needing to fully pay off existing loans. Meanwhile, it gives sellers the opportunity to sell properties that are currently under an existing mortgage while earning interest and possibly facilitating a quicker sale.
Examples
1. Rental Property Purchase: If a landlord wants to sell a rental property with an existing mortgage but the potential buyer doesn’t qualify for a new mortgage, they could arrange for a wraparound mortgage agreement. In this scenario, the buyer makes payments to the landlord, who continues to pay the original mortgage. The monthly payment to the landlord is typically higher than the underlying mortgage payment, enabling the landlord to generate some income.2. Owner Transferring to Family Member: If a family member wishes to transfer their property (which still has an ongoing mortgage) to another family member who cannot qualify for a traditional mortgage due to poor credit, the current owner could establish a wraparound mortgage. This allows the family member to purchase the house by making payments to the existing owner, who continues to pay the original mortgage.3. Real Estate Investors’ Acquisition: Suppose a seasoned real estate investor identifies a property to acquire, which has an existing, low-interest rate mortgage. However, obtaining a new mortgage might be cost-prohibitive or time-consuming for the investor. In such a scenario, the investor might opt for a wraparound mortgage, where they make payments to the seller, who continues making payments on the property’s original mortgage. This strategy allows the investor to leverage the ongoing low-interest mortgage advantage. The investor can then resell or refinance the property, settling the wraparound mortgage.
Frequently Asked Questions(FAQ)
What is a wraparound mortgage?
A wraparound mortgage, also known as a wrap, is a type of secondary financing for buying property. The seller extends to the buyer loans that wrap around the existing mortgage owned by the seller.
How does a wraparound mortgage work?
A wraparound mortgage works in such a way that the borrower makes payments to the lender (seller) who then uses these payments to pay the original mortgage. Typically, the interest rate on the wrap mortgage is higher than on the original mortgage.
Is a wraparound mortgage legal?
Wraparound mortgages are legal, but they’re subject to various laws and regulations that vary by state, so it’s crucial to have legal counsel involved in these transactions. Additionally, the original lender can initiate a loan payoff if a due-on-sale clause exists, so careful review of the original mortgage terms is required.
What is the benefit of a wraparound mortgage?
The benefits to buyers include low down payments and access to financing that they might not otherwise be able to secure. For sellers, the advantages include earning potential interest on the wrap mortgage and being able to sell the property quickly, particularly in a slow market.
What are the potential drawbacks of a wraparound mortgage?
The risks for buyers include uncertainty over whether the seller will make timely payments on the original mortgage. For sellers, there’s the risk that the buyer might default, leaving the seller still responsible for the original mortgage.
Who is a wraparound mortgage best suited for?
A wraparound mortgage might be best suited for sellers in a slow market where potential buyers may have trouble accessing traditional financing, as well as buyers who can’t qualify for a traditional mortgage loan.
Can the original lender prohibit a wraparound mortgage?
If the original loan contract contains a due-on-sale clause, the lender can demand full payment on the loan if the property is sold, effectively preventing a wraparound mortgage from occurring. Therefore, it’s very important to check the terms of the original mortgage before proceeding.
How is the interest rate on a wraparound mortgage determined?
The interest rate on the wraparound mortgage is determined by the seller, often considering factors like the borrower’s creditworthiness, the current market rates and the term of the loan. Typically, the interest rate on a wraparound mortgage is higher than that of the original loan.
Related Finance Terms
- Subordinated Mortgage
- Seller Financing
- Promissory Note
- Junior Lien
- Real Estate Contract
Sources for More Information
