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. Here are the basics to know.
What is a wraparound mortgage?
A wraparound mortgage, also known as a carry-back loan, is a form of owner or seller financing in which the buyer gets a mortgage that includes, or “wraps around,” the existing mortgage the seller has on the property. The buyer makes one payment to the seller, which the seller uses in part to pay the first mortgage, and then pockets the remainder. In many cases, the wraparound mortgage will have a higher interest rate than what the existing mortgage had, so the seller can cover the payment and also profit.
“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.
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.
Risks of a wraparound mortgage
Because of the nature of wraparound mortgages, both the buyer and seller take on some level of risk. For one, because the buyer makes payments directly to the seller, the buyer relies entirely on the seller to pay the original mortgage.
“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.
If you’re considering a wraparound mortgage as a buyer, it may be 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.
Sellers also face risks in a wraparound mortgage, the biggest being 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.”
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 may be wise to consult with a real estate attorney who can advise you on the risks.