What Is a Wraparound Mortgage and How Does It Work?

A wraparound mortgage is a form of seller financing, allowing a property owner to extend credit directly to a buyer. The seller becomes the lender, providing a new loan that encompasses their existing mortgage debt. It offers an alternative path to homeownership outside traditional lending institutions. It facilitates transactions under specific market conditions or when conventional financing is less accessible.

Understanding a Wraparound Mortgage

A wraparound mortgage creates a new loan that “wraps around” an existing mortgage on the property. The original loan remains in place, and the seller continues to make payments on it, even as the buyer makes payments on the new wraparound loan. This structure involves three parties: the original lender, the original borrower (now the seller), and the new buyer.

The original lender holds the first mortgage on the property from the original borrower. With a wraparound mortgage, the original borrower (now the seller) finances the purchase for the new buyer. The buyer’s payments are directed to the seller, who then uses a portion to satisfy their obligation to the original lender. This creates a payment flow where the seller manages payments from the buyer and to the original mortgage holder.

This arrangement means the seller remains responsible for the original mortgage, even though the buyer’s payments are intended to cover it. The buyer obtains financing directly from the seller, under terms that may differ from those available through traditional banks. The wraparound loan amount includes the remaining balance of the original mortgage plus any additional equity the seller finances for the buyer. This method layers a new financing agreement on top of the existing one.

Components of the Wraparound Agreement

A wraparound mortgage defines its mechanics and implications. A new wraparound loan is established for the buyer, which incorporates the unpaid balance of the original mortgage. The buyer then makes a single payment to the seller, calculated based on the new wraparound loan amount and its interest rate. This payment covers both the original mortgage and any additional seller-financed portion.

Upon receiving the buyer’s payment, the seller is responsible for making the payment to their original lender, ensuring the original mortgage remains current. The remaining portion of the buyer’s payment, after covering the original mortgage payment, is the seller’s return on equity and interest earned on the wraparound loan. The interest rate on a wraparound mortgage is set higher than the rate on the original mortgage. This differential incentivizes the seller, generating additional income beyond a cash sale.

For lien structure, the wraparound mortgage creates a junior lien on the property. While the original lender’s mortgage remains the first lien, the wraparound mortgage includes this senior lien. The seller’s security interest for the wraparound loan is secondary to the original lender’s claim in case of default. Documentation, including a promissory note and deed of trust, outlines these financial and legal relationships.

Typical Situations for Wraparound Mortgages

Wraparound mortgages are relevant in specific market conditions or buyer circumstances where traditional financing options are less viable. One scenario involves buyers who have difficulty qualifying for conventional mortgage loans due to credit history limitations or insufficient down payments. A seller may be more flexible with qualification criteria, opening homeownership to more buyers. This flexibility is appealing when a buyer does not meet the underwriting standards of institutional lenders.

Wraparound mortgages are also used during periods of high prevailing interest rates. If the seller has an existing mortgage with a lower interest rate, a wraparound mortgage can offer the buyer a blended rate more attractive than current market rates for new financing. This allows the buyer to secure a lower effective interest rate than they obtain from a new bank loan. This strategy makes a property more affordable and appealing.

Sellers may use a wraparound mortgage to facilitate a quicker sale or attract more buyers, especially in a sluggish real estate market. Providing financing can make a property stand out and remove a hurdle for buyers struggling to get a loan. It allows the seller to generate income from the interest rate differential over the life of the loan. This is a strategic move for sellers divesting a property and creating an ongoing revenue stream.

Important Considerations for Parties

Parties engaging in a wraparound mortgage must be aware of several elements of this financing method. Many existing mortgages include a “due-on-sale” clause, which permits the original lender to demand full repayment if the property is sold or transferred. While wraparound mortgages do not directly transfer title like a traditional sale, the underlying lender could invoke this clause upon discovering the arrangement. This could force the seller to pay off the original loan, disrupting the wraparound agreement.

The seller remains liable for the original mortgage even after a wraparound agreement with the buyer. If the buyer defaults on payments to the seller, the seller must continue making payments to the original lender to avoid defaulting. This responsibility highlights the need for thorough buyer vetting and strong payment collection. The seller’s credit rating and the property are still tied to the original mortgage, regardless of the wraparound.

Effective payment collection and escrow arrangements are important for the operation of a wraparound mortgage. Using a third-party loan servicing company to collect payments from the buyer and disburse them to the original lender adds professionalism and security. This ensures timely payments and proper handling of funds, including property taxes and insurance premiums. Clear documentation, including promissory notes and deeds of trust, defines the terms, responsibilities, and remedies.

A buyer under a wraparound mortgage does not have a direct contractual relationship with the original lender. All financial interactions flow through the seller. This indirect relationship means the buyer relies on the seller to fulfill their obligation to the original lender. Buyers should ensure the wraparound agreement includes provisions allowing them to verify the seller is making payments on the original mortgage.