What Is a Wrap Around Loan? A Complete Guide to Understanding Wrap Around Mortgages

If you’re looking to buy or sell a home through an alternative financing method, you may come across something called a “wrap around mortgage” or “wrap around loan.” But what exactly is a wrap around loan and how does it work? In this comprehensive guide, we’ll explain everything you need to know about wrap around loans, including the definition, pros and cons, and examples of how they work in real estate transactions.

Wrap Around Loan Definition

A wrap around loan is a specialized type of mortgage that allows a home seller to essentially act as the bank for the buyer. Here are two key aspects that define these loans:

• The seller retains their existing first mortgage on the property when selling the home.

• The buyer takes out a second mortgage with the seller that wraps around or overlays the seller’s first mortgage

With a traditional purchase, the seller pays off their mortgage when the home is sold. But with a wrap around structure, the seller keeps their original mortgage in place while also offering financing to the buyer through a wraparound loan

The seller continues making payments on the first mortgage using funds from the payments received from the buyer on the wraparound second mortgage. This allows the transaction to move forward even if the buyer can’t qualify for traditional financing.

How Do Wrap Around Loans Work?

Here is an overview of how a wrap around mortgage works in a real estate transaction

• Seller has existing mortgage: The seller currently has a mortgage on the property from a bank or mortgage lender. This is known as the first mortgage.

• Buyer can’t qualify for conventional loan: The potential buyer is interested in purchasing the home but is unable to qualify for a traditional mortgage from a bank.

• Seller offers wraparound financing: Since the buyer can’t get a standard mortgage, the seller agrees to provide seller financing in the form of a wraparound second mortgage.

• Wraparound mortgage terms defined: The purchase price, interest rate, down payment amount, and payment terms are agreed upon for the wraparound loan between the buyer and seller. This is documented in a promissory note.

• Buyer makes payments to seller: The deed transfers to the buyer, who then makes monthly payments on the wraparound mortgage directly to the seller.

• Seller pays existing mortgage: The seller takes the buyer’s payments and uses the funds to continue making payments on their underlying first mortgage.

Essentially, the buyer’s new loan “wraps around” the seller’s existing mortgage, allowing the seller to keep their original mortgage in place at its current interest rate and terms. The seller collects a payment from the buyer and pays their lender each month.

Wrap Around Loan Example

Here is a hypothetical example to illustrate how a wrap around mortgage functions:

• John is selling his home for $250,000. He currently owes $100,000 on his mortgage at 4% interest.

• Mary wants to buy the home but cannot qualify for a traditional mortgage.

• John offers a wraparound mortgage to Mary at 6% interest with a $50,000 down payment and a loan amount of $200,000.

• Mary pays John $1,000 per month on the wraparound loan based on the agreed upon interest rate and balance.

• John takes $400 of Mary’s $1,000 payment to pay his existing mortgage. The remaining $600 is profit since John’s mortgage is at 4%.

In this example, the wrap structure allowed the sale to proceed even though the buyer could not get traditional financing. The seller also profits from the difference in interest rates between the two loans.

Pros and Cons of Wrap Around Loans

Wrap around mortgage loans offer unique benefits but also come with notable risks:

Pros for Buyers

• Easier to qualify than conventional mortgages
• May have lower closing costs by avoiding bank fees

Cons for Buyers

• Higher interest rates than traditional loans
• Risk of foreclosure if seller defaults on underlying first mortgage

Pros for Sellers

• Ability to profit from the difference in interest rates
• Can expand pool of eligible buyers by offering financing

Cons for Sellers

• Take on all risk if buyer stops making payments
• Existing mortgage cannot have a due-on-sale or alienation clause

As you can see, both buyers and sellers take on notable risks with a wraparound structure. Working with a real estate attorney is highly recommended.

Alternatives to Wrap Around Financing

For buyers who don’t qualify for traditional mortgages, other types of creative financing may be available including:

• Seller financing: Buyer finances a portion of the home price directly from the seller.

• lease-option: Buyer leases the home short-term with the option to purchase later.

• Land contract: Similar to a lease-option but involves incremental purchases of equity in the property over time.

The Bottom Line

A wrap around mortgage allows a home seller to provide financing to a buyer by retaining their existing first mortgage on the home while offering a second mortgage that wraps around the first. This unique structure comes with advantages and disadvantages for both parties. With creative financing in high demand among home buyers, wrap around mortgages offer an alternative path to homeownership when traditional mortgages aren’t accessible.