A wraparound mortgage is a lesser-known, unique financing option. It’s far from a conventional loan, but can be an opportunity for both homebuyers struggling to obtain a mortgage and sellers in distress.
What is a wraparound mortgage?
A wraparound mortgage, also known as a carry-back loan, is a form of owner or seller financing. The buyer gets a mortgage that includes, or “wraps around,” the existing mortgage the seller has on the property.
The buyer then makes payments to the seller, who then pays the lender on the first mortgage and pockets the remainder. In many cases, the wraparound mortgage will have a higher interest rate than the existing mortgage, so the seller can cover the payment and also profit.
How do wraparound mortgages work?
Only assumable loans can become part of a wraparound mortgage. Conventional loans aren’t typically assumable, but FHA, USDA and VA loans are.
The buyer and seller also have to agree to the wraparound mortgage, and the seller needs to obtain permission from the lender before moving forward with the loan. Once terms are in place, the seller might either transfer the home’s title to the buyer right away or transfer the title once the loan is repaid. Once the title is transferred, the buyer is considered the owner of the property.
Wraparound mortgages are in a junior or second lien position on the property. So if the buyer can’t or doesn’t make payments, the lender — not the seller — would be repaid first from the proceeds of a foreclosure sale. In other words, the lender would benefit before the seller is able to recoup any losses.
Example of a wraparound mortgage
Say a seller has a remaining mortgage balance of $100,000 with an interest rate of 5 percent on a home worth $200,000. The seller finds an interested buyer who is unable to qualify for traditional financing.
To cover their risk, the seller agrees to a wraparound mortgage of $150,000 — including a $10,000 down payment — and an interest rate of 7 percent. The seller is able to pocket the excess $50,000. As they continue to make payments at the 5 percent interest rate, they are also able to make money off the 2 percent difference between their original rate and the new interest rate.
Wraparound mortgages also work if the buyer and seller agree to a loan that covers only the remaining amount. Even if the buyer only takes on a loan of $100,000 in this scenario, the seller still profits off the 2 percent rate difference between loans.
Benefits of a wraparound mortgage
A wraparound mortgage allows a buyer to get financing that they might not otherwise qualify for. The buyer might also be able to borrow less — enough to cover the remaining loan balance and a small profit for the seller — than if they were buying the property with a standard mortgage.
“A wraparound mortgage is a good idea when the buyer does not qualify for any mortgage products with lenders,” explains Benjamin Schandelson, a mortgage loan originator and head of marketing with MJS Financial LLC in Boca Raton, Florida.
For sellers, the win is the potential for profit.
Risks of a wraparound mortgage
Because of the nature of wraparound mortgages, both the buyer and seller take on some level of risk. As the buyer, you make payments directly to the seller, so you’re relying entirely on them to pay the original mortgage. It’s wise to add a clause to your loan or purchase agreement that would allow for a portion of your payments to be made directly to the lender, instead of all of the payment going to the seller.
“The biggest risk is the seller defaulting on the original mortgage, which can put the property the buyer is living in into foreclosure,” says Schandelson.
Sellers also face risks in a wraparound mortgage, mainly the buyer not making payments and the seller still being on the hook to repay it.
“This means you either need to come out of pocket or miss payments, which can hurt your credit score,” says Schandelson. “You might also need to take legal action against the buyer for not paying, which can be costly.”
Alternatives to a wraparound mortgage
Wraparound mortgages are generally better reserved for buyers in higher-rate environments. Although they can help buyers with poor credit, they aren’t the only option when rates are low: an FHA or USDA loan can be a solution. Not only do these types of mortgages have lower down payment requirements, but also, you might still be able to nab a competitive rate, even without good credit.
On the other side, sellers having difficulty finding a buyer might want to consider alternatives to selling. Using the home as an investment property, for example, could still bring significant profit with a similar level of risk.
A wraparound mortgage is a creative way for a buyer and seller to facilitate a transaction, but there are risks on both sides. Buyers will need to find the right seller who’s willing to work with their situation. Options might include a seller who’s having a difficult time unloading their home or one who’s facing the consequences of an inability to pay their mortgage.
Once you find the property you want and an agreeable seller, the original lender will need to be contacted for approval as well. Before moving forward with a wraparound mortgage, it’s smart to consult with a real estate attorney who can advise you on the risks.