What is a wraparound mortgage?

A wraparound mortgage is an unconventional form of home financing. It requires the seller to keep their existing mortgage on the home, and the buyer makes payments to the seller rather than taking out a traditional mortgage. The seller makes a profit by charging additional interest on top of their original mortgage.

Like all loans, there are pros and cons to consider before deciding if a wraparound mortgage is a viable option for you.

How wraparound mortgages work

When a home is sold, the buyer obtains their financing independently and the seller receives their money for the house at closing.

A wraparound mortgage requires the buyer to make payments directly to the seller while the seller continues to pay off their original mortgage.

With a wraparound mortgage, however, the buyer and seller are both involved in the financing of the home — the seller maintains the existing mortgage on the home they're selling. They essentially become the lender for the buyer, offering what is commonly referred to as owner financing.

Here's how the process works:

1. A buyer and seller reach an agreement for the sale of the home. They agree upon a sale price, a down payment amount and an interest rate for the loan.
2. Both parties complete a promissory note that outlines the details of the arrangement.
3. At this point, the title and deed may transfer to the buyer. However, some wraparound mortgage agreements will require the loan to be repaid before the title is transferred.
4. The buyer makes payments to the seller to cover the entirety of the mortgage, plus whatever interest was agreed upon.
5. The seller continues making payments on their original loan, earning the difference between their underlying loan payment and the higher amount they get from the buyer.

An example of a wraparound mortgage:

A seller would like to sell a home they've owned for several years. The home is worth $200,000, and the seller still owes $100,000 on their mortgage with a 4% APR (annual percentage rate).

A potential buyer would like to purchase the home for $200,000 and can afford a down payment of $25,000. However, because of past credit trouble, the buyer cannot qualify for a traditional mortgage on their own.

The seller doesn't want to miss out on the opportunity to sell the home and believes the buyer will uphold their end of the deal, so they agree to a wraparound mortgage. The buyer pays the seller the down payment of $25,000, and the seller finances the remaining $175,000 of the sale price.

The seller keeps their existing loan of $100,000 and lets the buyer pay the financed amount of $175,000 with an interest rate of 6%. The seller profits from the 2% increase over the original APR, and the buyer gets a home they could not have otherwise qualified for.

Wraparound mortgage benefits

A wraparound mortgage can benefit someone who doesn't meet lending requirements but is dedicated to finding and buying a house. It's a mutually beneficial lending approach in the right situation.

Benefits for the seller:

• The seller can sell their home without waiting for the traditional mortgage process.
• The seller continues making monthly payments on their original mortgage, bolstering their credit history.
• The seller may fetch a higher sale price since they're taking a risk and making concessions that benefit the borrower.
• The time to close can be significantly faster.
• The sale is unlikely to fall through due to financing issues.

Benefits for the buyer:

• The buyer can purchase a home they could not qualify for with a traditional loan.
• The buyer can avoid normal lending requirements, such as credit score and income qualifications.
• The buyer can close on a house faster.

Wraparound mortgage drawbacks

While there are clear benefits to a wraparound mortgage for both the buyer and seller, it’s essential to consider some potential drawbacks.

If the seller doesn't make their mortgage payments, their lender can foreclose on the home.”

The buyer and seller are very much in it together with this type of loan. If the seller doesn't make their mortgage payments, their lender can foreclose on the home, even if the buyer has been making payments as agreed. Likewise, if the buyer fails to make payments to the seller, the seller may be unable to keep up with their original mortgage payments.

These drawbacks underscore the importance of a detailed contract. A contract should outline all the terms and expectations of both parties, including remedies in the event of default.

Wraparound mortgage vs. second mortgage

A wraparound loan is different from a second mortgage. A second mortgage is a new loan that's issued to a homeowner on top of their existing mortgage. The equity in the home generally secures the second mortgage, which often has a higher interest rate than the primary mortgage. A second mortgage does not include the original mortgage. Instead, it's in addition to the underlying first mortgage.

A wraparound mortgage, on the other hand, includes the original mortgage. It's only used to sell a home where the seller wants to provide financing to the buyer. The seller continues making payments on their original loan and receives payments from the buyer. A wraparound mortgage is not a new loan. It's a different way of financing the sale of a home.

Bottom line

A wraparound mortgage can be a helpful way for you to buy a home when you cannot meet traditional lending requirements. The seller benefits from a motivated buyer, profit on interest, a potentially higher sale price and the ability to sell their home quickly. The buyer benefits from not having to meet traditional lending requirements and a faster time to closing.

However, there are risks for both the buyer and seller. Both parties are at risk of foreclosure if the other fails to make payments as agreed. Therefore, a detailed contract outlining all expectations is essential for both parties.

A wraparound mortgage is a viable approach in the right situation. However, both parties should thoroughly consider all the pros and cons before reaching a final agreement.