What is a wraparound mortgage? (2024)

Alternative home financing for those with poor credit

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When most people think of a mortgage, they picture a traditional, 30-year fixed-rate conventional loan, but there are numerous alternatives available.

One of those options is a wraparound mortgage. It’s an unconventional form of home financing in which the seller keeps an existing mortgage on their home while the buyer makes monthly payments to the seller — bypassing the traditional lending process.

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


Key insights

  • A wraparound mortgage is a form of secondary financing where the seller maintains the mortgage and acts as the lender for the buyer.
  • The buyer makes payments to the seller each month and the seller maintains responsibility for making monthly payments to the lender.
  • Although it has numerous advantages for both buyers and sellers, a wraparound mortgage comes with a substantial amount of risk.

Wraparound mortgages explained

A wraparound mortgage is a loan that includes, or “wraps around,” the current mortgage on a property. It not only includes the current mortgage loan, but also a new loan between the buyer and seller covering the purchase of the property.

It’s a form of secondary financing — meaning, it’s neither a traditional first mortgage or a gift, but does create a lien on the property.

With this arrangement, the seller maintains the original mortgage note while the buyer makes monthly payments to the seller, often at a higher interest rate so the seller can take in additional funds and cover the original note.

How wraparound mortgages work

Under traditional lending circumstances, the buyer obtains financing on their own, independent from the seller. The seller receives their money for the home purchase at closing. However, this process is entirely different when using a wraparound mortgage.

With a wraparound mortgage, the buyer and seller are both involved in the financing of the home. The buyer makes payments directly to the seller while the seller continues to pay off their original mortgage.

The seller essentially becomes the lender for the buyer, offering what is commonly referred to as owner financing.

Here's how the process works:

  • 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.
  • Both parties complete a promissory note outlining the details of the arrangement.
  • The title and deed may transfer to the buyer. However, some wraparound mortgage agreements require the loan to be repaid before the title is transferred.
  • The buyer makes payments to the seller to cover the entirety of the mortgage, plus whatever interest was agreed upon.
  • 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.

Although the buyer and seller bypass a traditional lender, hiring a real estate attorney on both sides is a smart approach. Additionally, the original mortgage lender has to agree to adding on a secondary loan, even if they’re not the ones providing the financing.

» COMPARE: Best mortgage lenders

Wraparound mortgage example

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.

» MORE: What credit score is needed to buy a house?

Pros and cons of a wraparound mortgage

There are several advantages to a wraparound mortgage for both the buyer and the seller.

“The main pro for buyers is they don’t need to obtain a new mortgage so this should make it easier to qualify, resulting in more flexible terms and lower closing costs,” said Dan Mugge, COO of Calque, Inc., a company that partners with lenders to offer noncontingent mortgages to homebuyers.

The buyer can still purchase a home, even without meeting traditional credit and income requirements. Plus, both the buyer and seller can benefit from a quicker closing process, since there aren’t as many steps involved, such as a home appraisal.

The main pro for buyers is they don’t need to obtain a new mortgage so this should make it easier to qualify, resulting in more flexible terms and lower closing costs.”
— Dan Mugge, Calque, Inc.

Sellers benefit from this arrangement too, not only with faster closings and bypassing traditional lenders, but also by making more money (depending on the structure of the arrangement). Plus, the seller can have a higher degree of confidence the purchase will go through, since less approvals are required.

But this secondary financing isn’t without risk.

“Since the buyer is dependent upon the seller to keep the mortgage current there is risk of default if the seller stops making payments,” said Mugge. “Other cons include risk of unknown title issues, a potentially higher interest rate and lack of full control of the property since it is in another’s name.”

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. A buyer can also lessen the risk by making payments directly to the seller’s mortgage company, if the lender allows it.

» MORE: How to stop foreclosure

Pros and cons for buyers

While there may be benefits to a wraparound mortgage for the buyer, this type of financing has drawbacks.

Pros

  • Buyer can purchase a home they may not otherwise qualify for
  • Buyer doesn’t have to meet income or credit requirements
  • Quicker closing time

Cons

  • Property can go into foreclosure if the seller misses payments
  • Doesn’t build the buyer’s credit

Pros and cons for sellers

Sellers should carefully consider all aspects of a wraparound mortgage before agreeing to take on the financial risk.

Pros

  • Seller continues building stronger credit if payments made on time
  • Seller can profit off the buyer paying a higher interest rate
  • Quicker closing

Cons

  • Must meet legal requirements from lender
  • Seller on the hook for payment if the buyer doesn’t pay

Alternatives to a wraparound mortgage

A wraparound mortgage isn’t a buyer’s only option if they’re struggling to meet credit or income requirements for a home loan.

  • FHA loans: FHA loans are backed by the Federal Housing Authority and can be a great option for someone who may have a lower credit score or a small amount for a down payment. Not only do these loans have lower credit requirements, but you can often roll the closing costs into the mortgage.
  • VA loans: VA loans, backed by the Department of Veterans Affairs, offer active military members or veterans a chance at homeownership with flexible mortgage options. These loans often have lower credit score requirements, no down payment requirement and no private mortgage insurance.
  • USDA loans: A USDA loan, backed by the U.S. Department of Agriculture's Rural Development Guaranteed Housing Loan program, offers lending opportunities for rural areas. It too has lower credit score requirements, lower fixed-interest rates and no down payment options for those who qualify.

» MORE: How long does it take to buy a house?

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    FAQ

    Is a wraparound mortgage the same as a second mortgage?

    A wraparound loan is different from a second mortgage. A second mortgage is a new loan issued to a homeowner on top of their existing mortgage, and does not include the original mortgage. A wraparound mortgage includes the original mortgage and is not a new loan.

    Who holds the title with a wraparound mortgage?

    With a wraparound mortgage, the seller can either transfer the title to the buyer once the paperwork is signed, or wait and transfer the title when the loan is completely paid off.

    Who is liable in a wraparound mortgage?

    Both the buyer and seller remain liable in a wraparound mortgage. The buyer must pay the seller monthly payments and the seller must maintain the monthly payments to the mortgage lender.

    Are wraparound mortgages illegal?

    Wraparound mortgages are legal, but do involve risk. The best course of action is for both the buyer and the seller to each have a real estate attorney representing their interests and ensuring the paperwork reflects the agreement correctly.

    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.


    Article sources
    ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
    1. HUD.gov, “ Secondary Financing .” Accessed Sept. 6, 2023.
    2. HUD.gov, “ Let FHA Loans Help You .” Accessed Sept. 6, 2023.
    3. VA.gov, “ VA Home Loans .” Accessed Sept. 6, 2023.
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