What Is a Wraparound Mortgage & How Does It Work?

A wraparound mortgage represents a form of seller financing in real estate transactions. In this arrangement, the seller maintains their existing mortgage on the property while extending a new loan to the buyer. This new loan effectively “wraps around” the seller’s original financing, creating a single, larger debt for the buyer. It allows a property purchase to proceed without immediate involvement from a traditional bank for the buyer’s primary financing.

The Mechanics of a Wraparound Mortgage

A wraparound mortgage involves three parties: the original lender, the seller (who becomes the wraparound lender), and the buyer (the wraparound borrower). The seller retains their existing mortgage with the original lender, which remains in the first lien position. The seller provides financing to the buyer, creating a new loan that includes the outstanding balance of the original mortgage plus any additional funds needed for the purchase.

The financial structure of this arrangement involves two layers of debt. The buyer’s new wraparound mortgage is for the full purchase price minus any down payment, encompassing the seller’s underlying mortgage. This means the buyer makes a single payment directly to the seller each month.

Upon receiving the buyer’s payment, the seller uses a portion of these funds to continue making their scheduled payments on the original, underlying mortgage. Any remaining amount from the buyer’s payment is kept by the seller, representing their return on the financing provided. This creates a direct financial link and responsibility between the buyer and seller.

The interest rate on the wraparound mortgage is set higher than the rate on the seller’s existing mortgage. This difference in interest rates, known as the “spread,” contributes to the seller’s profit from the financing arrangement. For instance, if the seller’s original loan has a 4% interest rate and the wraparound mortgage is at 6%, the seller earns the 2% difference on the loan.

The total amount of the wraparound mortgage covers the original loan’s remaining balance and any additional equity or funds the seller wishes to finance for the buyer. This comprehensive amount forms the basis for the buyer’s payment schedule and the seller’s continued obligations to their original lender. The seller becomes the lender to the buyer.

Situations Where Wraparound Mortgages Arise

Wraparound mortgages arise when traditional bank financing presents challenges for buyers. This can occur if a buyer has difficulty securing a conventional loan due to credit history issues, a lack of a substantial down payment, or if the property itself does not meet standard lending criteria.

Sellers with existing mortgages that carry low interest rates may find wraparound mortgages appealing. They can attract a broader pool of buyers, especially in a market where prevailing interest rates are higher. The seller benefits from the interest rate spread.

This financing method can also be a solution in economic conditions where traditional lending tightens. It provides an alternative pathway to homeownership for individuals who might otherwise be excluded from the conventional mortgage market.

Key Structural and Legal Considerations

A key legal consideration in a wraparound mortgage is the presence of a “due-on-sale” clause in the seller’s original mortgage agreement. This common clause allows the original lender to demand full repayment if the property is sold or transferred without their consent. While not always enforced, activation of this clause could compel the seller to pay off their loan, potentially disrupting the wraparound arrangement.

Proper documentation is essential for establishing a legally sound wraparound mortgage. This includes a promissory note, detailing the buyer’s promise to repay the loan, and a deed of trust or mortgage document, securing the loan against the property. A wraparound agreement also outlines the responsibilities of both the buyer and the seller.

Servicing arrangements for a wraparound mortgage can vary. Payments may be handled directly between the buyer and seller, but a third-party loan servicing company is engaged. These companies manage the collection of payments from the buyer, disburse funds to the original lender, and provide accounting and tax statements.

Recording the wraparound mortgage in public records is an important step. This legal action establishes the lien priority, placing the wraparound mortgage in a second lien position behind the original mortgage. Recording protects the buyer’s interest in the property and provides public notice of the financing arrangement.