In a real estate transaction, when a buyer cannot qualify for a traditional mortgage, it can cause a lot of problems for both the buyer and seller. If you ever find yourself in this situation, there are some alternative methods of financing that you should know about.
A wraparound mortgage can get the buyer the financing required to purchase the home and can help to turn a profit for the seller. This can be a winning solution for both parties. However there are some risks you should know about, so it’s very important to know what you’re getting into before using a wraparound mortgage.
What Is A Wraparound Mortgage?
A wraparound mortgage is a home loan that allows the seller to keep their existing mortgage while the buyer’s mortgage goes around, or “wraps” around the existing loan amount. As a form of secondary mortgage financing, wraparound agreements mean that the buyer will have to make monthly payments directly to the seller, usually at a higher interest rate than the original mortgage loan.
How Wraparound mortgages Work
In a standard real estate transaction, the buyer buys a home with a mortgage provided by a typical mortgage lender. The seller then uses the proceeds of the sale to pay off their existing mortgage on the home, and if there is anything left over, that is their profit. Simple, right?
With a wraparound mortgage, the seller maintains the existing mortgage on the home, offers seller financing to the buyer and wraps the buyer’s loan into the existing mortgage loan. Does that make sense to you?
In the situation stated above, the seller takes on the role of the lender. The buyer and seller agree to both a down payment and loan amount, sign a promissory note that specifies the terms of the mortgage and then the title and deed pass on to the buyer. It is important to note that the seller continues to make payments on the original mortgage, however they no longer own the home.
The buyer pays the seller a monthly mortgage payment. This is done often at a higher interest rate, while the seller of the home continues to pay their mortgage payment to their original lender. The wraparound mortgage is essentially a form of second mortgage, or can be referred to as a junior lien. The original lender can still foreclose on the house if the seller fails to pay the existing mortgage, so even if the buyer is making their payments, they could still lose the home if the seller decides not to pay the original lender.
Typically the seller will pay the original mortgage with the payments they receive from the buyer. Most wraparound mortgages will have higher interest rates than a conventional mortgage, so the seller will typically make a profit from the second loan.