What Is a Wrap Mortgage and How Does It Work?
Discover wrap mortgages: a layered real estate financing approach that integrates an existing property loan into a new agreement.
A wrap mortgage is a form of seller financing, where the seller provides a loan to the buyer instead of a conventional bank loan. This arrangement establishes a direct lending relationship between the seller and the buyer. It is structured around an existing mortgage on the property, which remains in place throughout the new financing agreement.
Understanding the Wrap Mortgage Concept
A wrap mortgage is a new, larger loan that “wraps around” an existing, smaller mortgage on a property. The original mortgage is not paid off but continues to exist, with the seller remaining responsible for its payments. Instead of the buyer obtaining a separate loan from a bank, the seller acts as the lender, extending credit to the buyer. This new loan includes the outstanding balance of the seller’s original mortgage, along with any additional equity the seller is financing for the buyer to reach the agreed-upon purchase price.
The seller creates a new loan agreement with the buyer, often secured by a promissory note and a wraparound deed of trust. The buyer’s loan amount covers the total purchase price, minus any down payment, and incorporates the seller’s existing mortgage. For instance, if a seller owes $100,000 on an existing mortgage and sells the property for $150,000, the wrap mortgage would be for the $150,000 (assuming no down payment), which implicitly includes the original $100,000. The buyer makes payments on this single, larger loan to the seller, who then manages the original underlying debt.
The Mechanics of a Wrap Mortgage
A wrap mortgage involves a distinct payment structure. The buyer makes a single, consolidated monthly payment directly to the seller. This payment is typically higher than the seller’s original mortgage payment to their lender. Upon receiving the buyer’s payment, the seller then uses a portion of these funds to continue making payments on their underlying, original mortgage to their primary lender. The remainder of the payment, if any, is retained by the seller.
The interest rate charged on the wrap mortgage to the buyer is generally higher than the interest rate on the seller’s existing underlying mortgage. This difference in interest rates allows the seller to generate a profit, as they are effectively earning interest on the entire wrapped loan amount while paying interest on only the smaller, original loan. For example, if the seller’s original mortgage has a 4% interest rate and the wrap mortgage is set at 6%, the seller profits from the 2% spread on the portion of the loan that corresponds to their original mortgage balance, in addition to earning the full 6% on any new funds they financed.
The buyer pays the seller, and the seller pays the original lender. The seller effectively acts as a financial intermediary, managing the debt service for both the new wrap loan and the existing underlying mortgage. This mechanism ensures that the original lender continues to receive their regular payments.
Essential Components and Scenarios
A wrap mortgage transaction involves distinct roles for the participating parties. The buyer acts as the new borrower, making payments to the seller. The seller takes on a dual role: they are the lender to the buyer and simultaneously remain the original borrower responsible for the underlying mortgage to their initial lender. The original lender is generally not a direct party to the wrap agreement.
A significant consideration in these transactions is the “due-on-sale” clause, commonly found in most traditional mortgage agreements. This clause grants the original lender the right to demand full repayment of the loan if the property is sold or transferred. While a wrap mortgage typically involves transferring the property title to the buyer, the original mortgage remains in the seller’s name, which could potentially trigger this clause. However, lenders often do not enforce this clause as long as regular payments on the original mortgage are consistently made.
To manage the payment flow and mitigate risks for both the buyer and seller, it is common practice to utilize a third-party loan servicing agent or an escrow company. This independent entity collects payments from the buyer, ensures timely payments are made to the original lender, and remits any remaining funds to the seller. This arrangement provides an impartial record of payments and helps assure the buyer that their payments are being appropriately applied to the underlying mortgage, reducing the risk of the seller defaulting on their original loan.
Wrap mortgages are often considered in specific market conditions or buyer situations. They can be particularly useful when traditional financing is difficult for the buyer to obtain, such as during periods of high interest rates, tight lending standards, or if the buyer has a less-than-perfect credit history. For sellers, offering a wrap mortgage can expand the pool of potential buyers, facilitate a quicker sale, or provide an ongoing income stream from the interest rate differential. They serve as an alternative financing solution when conventional mortgage options are not feasible or desirable for either party.