What is a Wrap-Around Mortgage? A Quick Overview
For those who are unable to qualify for a traditional mortgage loan, home ownership may feel out of reach. This can be even more frustrating for both the buyer and the seller if the buyer is struggling to qualify after they’ve found the home of their dreams. However, all is not lost because there may be another option for financing that will get the deal closed for both the buyer and seller.
Some people might benefit from a wrap-around mortgage, which helps the buyer get the financing necessary to buy the home and ensure the seller turns a profit. There are some risks, however, that come along with a wrap-around mortgage. Whether you are the buyer or the seller, understanding all that a wrap-around mortgage entails is key before you decide to use one.
Defining a Wrap-Around Mortgage
A wrap-around mortgage is a type of loan in which the seller is able to hang on to the mortgage they have in place white the buyer’s new mortgage wraps around the balance that’s owed. With a wrap-around loan, the buyer will make payments to the seller each month as opposed to a traditional lender. This type of secondary mortgage financing typically comes along with a higher interest rate than the existing mortgage in order to be profitable for the seller.
Traditionally, a buyer would purchase their home using a mortgage loan that they get from a bank or mortgage lender. The seller, in turn, uses the amount they receive for the sale to make a lump sum final payment on their home’s existing mortgage.
Alternatively, with a wrap-around mortgage, the seller maintains their existing mortgage and offers their own financing to the buyer, wrapping their loan into the mortgage that they already have. Essentially, in this scenario, the seller is stepping into the shoes of a lender.
Whereas traditional mortgages are mediated by a lender, with a wrap-around mortgage, the buyer and seller come to a mutual agreement regarding the down payment and loan amounts, sign a document that outlines the terms of the mortgage, and pass the title and deed to the buyer. Even though the seller is still making payments toward their original mortgage, they are not the owner of the home.
Each month, the buyer pays a monthly mortgage payment to the seller and the seller keeps making mortgage payments to their original lender. The wrap-around mortgage becomes a junior lien, which is another term for a second mortgage.
The Benefits and Risks of Wrap-Around Mortgages
Perhaps the greatest benefit of a wrap-around mortgage for the seller is the potential to make a profit as a result of charging the buyer a higher interest rate. Wrap-around mortgages can also be vital in helping sellers who are having a hard time selling their homes. For buyers, wrap- around mortgages often offer a path to homeownership when traditional routes are not an option. Wrap-around mortgages tend to offer more flexibility and are easier to be approved for than conventional loans.
The risks of a wrap-around mortgage have the potential to impact both buyers and sellers. Remember, the original mortgage remains the primary loan, meaning the wrap-around mortgage is a junior lien. As a result of the junior lien’s position, if the seller stops making payments on the loan, the original lender can still foreclose on the home, even if the buyer has been making payments to the seller. This is where the element of risk comes in for both the buyer and the seller. If either party fails to live up to their end of the deal, both parties will suffer the repercussions. To avoid this potential risk, many buyers choose to make their payments directly to the original lender.
Furthermore, sellers take on the legal risk attached with a wrap-around loan. The seller is fully responsible for ensuring that the original mortgage is paid. In the event that the buyer fails to make payments, the seller is responsible for paying the original lender out of their own pocket.
While wrap-around loans certainly have the potential to be a great option for both parties, it’s important to enter into a wrap-around loan fully understanding both the benefits and the risks.