All about wraps
What’s a Wrap Around Mortgage?
Put simply a wrap around mortgage is a new mortgage that is created on a property that “wraps around” an existing mortgage. Wrap around mortgages, or ‘wraps,’ are typically used when selling a home with owner financing
Wrap Around Mortgage | Example:
Value of Home: $150,000
Original loan amount: $130,000
Original interest rate: 6% (fixed rate mortgage)
Investor’s Offering: $97,500
The owner can sell the home using a wrap around mortgage to a new buyer with the following terms:
Sales price: $155,000
Down Payment: $10,000
New “wrap around mortgage” amount: $145,000 (the balance on the new loan)
New “wrap around mortgage” interest rate: 7.5%
In this example, the homeowner would get to keep the $10,000 down payment (which will help to cover closing costs), and collects the monthly mortgage payment of $1013 (7.5% on the $145,000 loan), which is used to pay the existing mortgage payment of $780 (6% on the $130,000 loan) resulting in $233/month in positive cash flow.
As for taxes and insurance, the seller that creates the wrap around mortgage can pass the existing escrow to the new buyer or they can create a new escrow account to account for these expenses.
The major disadvantage to selling a home with a wrap around mortgage that there is always a possibility that the new buyer could stop making payments. If this happens the seller in the transaction would have to foreclose on the property, take over possession, repair the home if needed, and then sell the property again. This can be a very costly circumstance and by some estimates, this occurs in 70% of owner financed transactions. There are several ways in which to structure these deals and evaluate your buyer that can make your success rate much higher.
Common Questions About The Wrap Around Mortgage
Can any home be sold with a wrap around mortgage?
For the most part, Yes. Even in cases where there are multiple liens on a property, a new wrap around mortgage could be created and then sold to a buyer. In rare cases, a seller will create a wrap around mortgage for which the monthly payment is less than the underlying mortgage payments, which results in negative cash flow for the seller. Why would a seller do that? In some circumstances this may be the only way to get the home sold.
How long does the wrap around mortgage last and what happens when the buyer sells or refinances?
Most sellers that use a wrap around mortgage will structure the deal so that the buyer is required to refinance the ‘wrap’ after some period of time, 2 to 5 years is pretty common. If the buyer does not refinance in that time period, the seller can structure penalties in the contract such as having the interest rate rise at periodic time increments. When the buyer does get the home refinanced, or sells the home, the seller’s original loan is paid off and the remaining balance is then paid to the seller. In the example above, the seller would receive $15,000 when the home is refinanced or sold by the new buyer. This is called “the back end profit”.
Can the lender call the loan if I use a wrap around mortgage?
Technically they could, but they most likely would not. Almost all mortgage documents have a provision stating that whenever a home is sold, the lender has the right to “call the loan due”. This is called the “due on sales clause.” That being said, we have never seen a case in which a lender actually calls a loan in which the loan payments are being made in a timely manner.