When a buyer can’t qualify for a traditional mortgage loan, it can make for a rough sale for both the buyer and seller. While the situation may seem impossible, there may be another financing option for both parties to close the deal.
A wraparound mortgage can provide the buyer with the financing they need to purchase a home, and it may even make the seller a profit. However, wraparound mortgages come with risks, so it’s important to know what you’re getting into before using one to buy or sell a home.
A wraparound mortgage is a home loan that allows the seller to maintain their existing mortgage while the buyer’s mortgage “wraps” around the existing amount owed.
Instead of paying a bank or lender, the buyer makes monthly payments directly to the seller. In turn, the seller uses a portion of the buyer’s monthly payments to continue making their mortgage payments. Since most wraparound mortgages often have higher interest rates than conventional mortgages, sellers can typically profit from the rate they charge a buyer.
In a typical real estate transaction, a buyer purchases a home with a mortgage issued by a mortgage lender. The seller then uses the proceeds from the sale to pay off their existing mortgage.
With a wraparound mortgage, the seller keeps the existing mortgage on the home. They offer seller financing to help the buyer complete the purchase and then wrap the buyer’s new loan over their existing mortgage. In this situation, the seller takes on the role of the lender.
The buyer and seller agree to a down payment and loan amount, then sign a promissory note laying out the mortgage’s terms.
After both parties finalize the transaction, the seller transfers the title and deed to the buyer. While the seller continues to make payments on the original mortgage, they no longer own the home.
For a wraparound mortgage to work, the seller’s mortgage must be an assumable mortgage. If not, the seller’s lender may see a wraparound agreement as a violation of the original loan terms.
The wraparound mortgage takes the second or junior lien position, while the seller’s mortgage remains in the first lien position. If the buyer fails to make their monthly payments and the default results in foreclosure, the seller’s lender will get repaid first from the sale of the home. As the junior lien “lender,” the seller will receive any leftover funds after the original lender is fully repaid.
Here’s an example of how a wraparound mortgage works:
Sam is selling a home for $160,000 and has an existing mortgage balance of $40,000 at a 4% fixed interest rate. Sam decides to finance a loan for Alex (the buyer) to purchase the home. Sam and Alex agree to a $10,000 down payment and $150,000 wraparound mortgage at a 6% fixed interest rate.
Alex pays Sam every month, and Sam uses the funds to continue paying off the original mortgage and pockets the difference between the two payments. Sam can make a healthy profit thanks to the 2% difference in interest rates.