What Is a Wraparound Mortgage?

Written by Elijah BishopUpdated: 12th Jan 2022
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Qualifying for traditional mortgage financing can be challenging, especially as a first-time homebuyer. From strict qualification requirements to the lengthy approval process, leading to a rough sale for both the buyer and seller. That is why it is common for the average home buyer to turn to alternative mortgage financing to fund their home purchase. 

One such alternative mortgage financing option is the wraparound mortgage. If you’re in the market for mortgage financing, you may be wondering what a wraparound mortgage is all about, how it works, and its pros and cons. 

Keep reading to learn how this mortgage financing option can benefit both sellers and home buyers in 2022. 

What Is a Wraparound Mortgage?

A wraparound mortgage allows the seller to keep their existing mortgage while the buyer’s mortgage “wraps” around it. The buyer makes monthly payments straight to the seller, sometimes at a higher interest rate than the initial mortgage.

Wraparound mortgages typically benefit the seller. This is because sellers can seek a higher interest rate than their present mortgage loan. So long as their buyers make their higher-interest payments on time, they can make a profit.

>> More: How to Apply for a Mortgage

How Does a Wraparound Mortgage Work?

In a conventional real estate transaction, the buyer obtains a mortgage from a mortgage lender, bank, or credit union. The seller then utilizes the sale proceeds to pay off their current mortgage.

However, with a wraparound mortgage, the seller continues to maintain the original mortgage on the house while still offering the buyer mortgage financing. The seller also wraps the buyer’s loan into the original mortgage loan. 

In this scenario, the seller acts in the position of a lender to the home buyer. And like a typical mortgage application process, a down paymentand loan amount will be agreed. They’ll both sign a promissory mortgage note, and the buyer gets the title and deed. The seller no longer owns the property yet continues to pay the original mortgage to their lender. 

The buyer makes a monthly mortgage payment to the seller, while the seller keeps paying their original lender. Wraparound mortgages are second mortgagesor junior liens. If the seller defaults on the current mortgage, the original lender can still foreclose on the home. 

The seller typically pays the original mortgage with the buyer’s installments. Due to the higher interest rates on wraparound mortgages, the seller typically makes money on the second loan.

Wraparound Mortgage Example 

Suppose Susan wants to sell her home for $200,000 since she can’t afford the rest of the mortgage. Her mortgage debt is $25,000, with a 3.5 percent fixed rate. After consulting with the lender, she is permitted to employ the wraparound mortgage. Susan finds a buyer for the property for $200,000. 

Because the buyer does not have the total amount, he puts down $10,000 and borrows $190,000 from Susan at 4.9 percent. The buyer and Susan sign the mortgage agreement, and Susan gives the buyer ownership. 

As agreed, the buyer pays Susan every month, and she pays down her superior (first) mortgage to the original lender. Because the buyer’s interest rate is greater than Susan’s, she benefits from the difference in the wraparound rate.

Who Is Eligible for a Wraparound Mortgage? 

Wraparound mortgages are an excellent choice for homebuyers who do not qualify for traditional mortgage programs due to poor credit history or scores. More importantly, only sellers with an original assumable loan can do a wraparound mortgage. 

An assumable loan is a type of mortgage financing arrangement that allows for transferring an existing mortgage loan and its terms from the current owner to a potential buyer. Generally, conventional loansdo not fall under the category of assumable loans.

Still, government-backed loans like VA, FHA, and USDA are all assumable loans and qualify for wraparound mortgage financing. 

What Are the Benefits of a Wraparound Mortgage? 

There are several benefits associated with using wraparound mortgage financing to buy a house. Below are some of the benefits for both sellers and buyers: 

Sellers 

Wraparound mortgages can help sellers in various ways. First, they allow sellers to benefit by pocketing the difference between the original and wraparound loan rates. This type of mortgage financing can also assist sellers in challenging markets. When interest rates are high, sellers can offer wraparound financing lower than the market rate. More importantly, it can help sellers attract homebuyers who can’t receive regular financing due to poor credit scores. 

Buyers

A wraparound mortgage allows buyers to obtain financing that they otherwise would not be able to get. A wraparound mortgage can help a buyer with bad credit receive a loan. Because a wraparound mortgage is a contract between the seller and the buyer, they can easily negotiate interest rates. A wraparound mortgage decision and home-buying procedure are usually quick.

What Are the Risks of a Wraparound Mortgage? 

Below are some of the risks associated with using a wraparound mortgage as a method of mortgage financing when looking to purchase a home. 

Sellers

A wraparound mortgage also exposes sellers to risks, the most significant being non-payment by the buyer. This means you have to pay cash or miss payments, which might harm your credit. 

More importantly, the seller may be faced with legal risks. If the seller still has an outstanding mortgage, the original online mortgage lender must approve the secondary loan. Most lenders require full repayment upon sale or transfer of ownership. This would stop the wraparound mortgage. Before negotiating loan or sale terms, you must verify your original loan documentation to ensure you can close the deal.

Buyers

Unlike typical mortgages, a wraparound mortgage requires the prior owner to continue paying the original mortgage lender. As a buyer, you run the danger of the seller discontinuing payments and losing your home. Before committing to wraparound mortgage financing, ask yourself these questions. “What if the seller of the wraparound mortgage default?”

Suppose you’re looking to take advantage of wraparound mortgage financing. In that case, you should consider including a clause in your loan or purchase agreement that allows you to pay part of your mortgage directly to the lender instead of the seller.

Are Wraparound Mortgages Safe?

While wraparound mortgages are generally considered safe, you must do your due diligence and understand the risks associated with them. Speak to a local real estate lawyer regarding the terms of the loans and read through the fine print before agreeing to a wraparound mortgage. 

Bottom Line: What Is a Wraparound Mortgage?

Wraparound mortgages are unique for buyers and sellers to close a deal, but they come with their share of risks. Buyers must discover a seller willing to deal with them. A seller who is having trouble selling their house or who cannot pay their mortgage may be an excellent option.

Contact the original lender for permission once you find the property and a seller willing to work with you. Before pursuing a wraparound mortgage, you should speak with a real estate lawyer about the potential pitfalls. 

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Elijah Bishop
Elijah Bishop

Elijah A. Bishop is a Senior Personal Finance Writer who has been writing about real estate and mortgages for years. He has a Bachelors of Arts Degree in Creative writing from Georgia State University and has also attended the Climer School of Real Estate. He also holds a realtor license and has been in and out of the US mortgage industry as a loan officer. Bringing over 15 years of experience, Elijah produces content that analyzes ethnicities, race, and financial well-being. His areas of expertise are mortgages, real estate, and personal loans.