What Is a Wraparound Mortgage?
A wraparound mortgage is a type of financing arrangement wherein an existing mortgage is retained and a new, larger mortgage is created to encompass the old one. This innovative method allows buyers to purchase a property without having to secure a separate, traditional mortgage. The seller essentially “wraps” the previous outstanding mortgage balance into a new one, often at a higher interest rate, providing a margin that nets them a tidy profit.
Key Takeaways
- Scope: Targets properties with existing mortgages, enabling a new financing layer that covers both the old and new debt.
- Nature: It’s a form of seller financing or secondary financing rather than a traditional loan from a financial institution.
- Benefits: Offers an alternative for buyers who might not qualify for conventional financing and provides sellers with a potential income stream.
- Risks: The seller maintains an enormous financial stake in the property until the wraparound mortgage is fully repaid.
How a Wraparound Mortgage Works
Imagine a homeowner looking to sell their house with an existing mortgage balance. Instead of finding a buyer who will directly assume the old mortgage or apply for a new one, the seller offers to loan the additional needed amount to cover the home’s full sale price, over and above the remaining balance of the original mortgage. The new buyer then makes one consolidated payment to the seller, who continues to pay off the original mortgage and pockets the difference.
This setup particularly appeals in scenarios where the buyer might struggle to secure financing through traditional means—due to issues like poor credit ratings. It also allows sellers to turn their home into an income-generating asset with potentially higher interest rates than the underlying mortgage.
Wraparound Mortgage vs. Second Mortgage
While they sound similar, wraparound and second mortgages are distinct:
- Wraparound Mortgage: An arrangement where the new loan encompasses both the existing loan’s balance and extra funds for the property’s purchase—effectively “wrapping” the initial debt.
- Second Mortgage: Represents an entirely separate loan taken on top of the first, generally at a higher interest rate and prioritized below the original in repayment hierarchy.
Example of a Wraparound Mortgage
For a clearer picture, consider Mr. Jenkins selling his home valued at $120,000 with an outstanding mortgage of $40,000. He offers to wrap this existing mortgage with a new loan amounting to $120,000 at an interest rate advantageously higher than the original. Ms. Buyer, unable to secure traditional financing, agrees to this arrangement. She pays Mr. Jenkins, who then continues paying off his old mortgage and enjoys the fruits from the higher interest rate of the wraparound mortgage.
Related Terms
- Seller Financing: An agreement where the seller provides the financing to the buyer instead of a bank, usually with a secured note.
- Junior Loan: A loan that is second in priority in terms of repayment in the event of default.
- Secured Promissory Note: A legal IOU that assures payment security backed by the collateral of the property.
Suggested Books for Further Studies
- “Real Estate Finance and Investments” by William B. Brueggemann and Jeffrey Fisher
- “Investing in Real Estate” by Gary W. Eldred
- “The Mortgage Encyclopedia” by Jack Guttentag
By wrapping your head around the wraparound, you might just find that it encapsulates the flexibility and innovation needed in contemporary real estate financing. After all, why settle for traditional when a wrap can bring everything together so neatly?
