A wraparound mortgage, also known as an “all-inclusive mortgage” or “wrap loan,” is a creative financing technique used in real estate transactions. It involves the seller financing the buyer’s purchase of a property while the existing mortgage loan on the property remains in place. Here’s how a wraparound mortgage works:
- Existing Mortgage: The seller of the property has an existing mortgage on it. Instead of paying off this mortgage when selling the property, the seller leaves it in place.
- New Mortgage: The buyer and seller agree on the sale price of the property, and the buyer provides a down payment. However, instead of the buyer obtaining a traditional mortgage from a bank or lender to cover the remaining purchase price, the seller provides financing by creating a new mortgage, which “wraps around” the existing one.
- Wraparound Mortgage Terms: The wraparound mortgage typically includes terms such as the interest rate, repayment schedule, and a provision that allows the seller to make payments on the existing mortgage from the payments received from the buyer.
- Payments: The buyer makes monthly mortgage payments to the seller based on the terms of the wraparound mortgage. The seller, in turn, continues to make payments on the existing mortgage using a portion of the buyer’s payments.
- Equity and Ownership: The buyer gains ownership of the property and equity over time as they make payments on the wraparound mortgage. The seller maintains ownership of the property until the wraparound mortgage is paid off.
Benefits of a Wraparound Mortgage:
- Flexible Financing: Wraparound mortgages can be beneficial for buyers who may not qualify for traditional mortgage loans due to credit issues or other factors.
- Lower Down Payment: Buyers may be able to secure a property with a lower down payment than what is typically required for traditional financing.
- Interest Rate: Depending on the terms negotiated, the interest rate on a wraparound mortgage may be more favorable than prevailing market rates.
- Avoiding Due-on-Sale Clause: In some cases, sellers may use wraparound mortgages to avoid triggering the “due-on-sale” clause in the existing mortgage, which could require full repayment of the loan upon the sale of the property.
Risks and Considerations:
- Default Risk: If the buyer defaults on the wraparound mortgage payments, the seller could face financial difficulties, including potential foreclosure by the existing lender.
- Due-on-Sale Clause: While wraparound mortgages can sometimes avoid triggering the due-on-sale clause, it’s essential to review the terms of the existing mortgage carefully. Some lenders may still choose to enforce the clause.
- Interest Rate Risk: The seller may be exposed to interest rate risk if the interest rate on the wraparound mortgage is significantly lower than the rate on the existing mortgage.
- Title Issues: Proper legal documentation is critical to ensure that the wraparound mortgage is recorded correctly and that the property’s title remains clear.
- Legal and Regulatory Compliance: Wraparound mortgages must comply with local, state, and federal laws and regulations. It’s advisable to work with Matthew Jennings, JD, MBA, EA, RFC®, CEP®, CES™, aka Tax King Matt.
Wraparound mortgages can offer benefits for both buyers and sellers in specific situations. However, they can also be complex transactions with potential risks, so it’s crucial to understand the terms and implications fully before entering into such an arrangement. Consulting with Tax King Matt is advisable when considering a wraparound mortgage.