Mortgages come in many shapes and sizes. The particular one we are going to talk about today is a wraparound mortgage. But what does wraparound mortgage mean?
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What is a Wraparound Mortgage?
According to the wraparound mortgage definition, it is basically a second mortgage you take out to cover your new house and the old one. So when you sell your house, the buyer will just make monthly payments to you instead of going to a lender.
The seller of the house takes the responsibility of lending money to a buyer. So in simple words, with a wraparound mortgage, if you are selling the house, you will buy a mortgage for both your new and old house. You will then transfer the mortgage agreement to the new buyer for the house you are selling. They will then be making monthly mortgage payments to you instead of to the bank or a lender.
The name “wrap around” comes from the fact that your mortgage not only covers your new house but also wraps around the old property.
Wraparound mortgages can be useful when the buyer does not have enough credit to get a traditional mortgage and when the housing markets are slow. However, even though the seller can earn a good profit from a wraparound mortgage, it does come with some risks, for buyers and sellers both.
How do Wraparound Mortgages Work?
If you get a wraparound mortgage, you will have to pay for the mortgage on your new home as well as the remaining mortgage on your old home. However, you would not have to pay the mortgage amount out of your own pocket for your old property. The buyer will send you monthly mortgage payments that you can use to pay off the mortgage for your old house. This way the buyer will be getting a mortgage from you instead of a traditional mortgage lender.
This new mortgage would also be considered a second mortgage or a junior mortgage.
A wraparound mortgage can only be created with an assumable loan. These are types of loans that allow sellers to transfer their mortgage to a buyer with some or no changes made to the original mortgage agreement. More specifically, the interest rate also stays the same when transferring the mortgage.
However, not all conventional mortgages are assumable loans. In order to understand your specific loan agreement, it would be a safe idea to speak to a real estate attorney.
What is a Wraparound Mortgage Used For?
It’s common to sell a house just to make a profit out of it. However, a wraparound mortgage can help you minimize that profit.
Market conditions will also play a part in determining how much you will make. But here are several reasons you might want to consider getting this type of loan:
1. To make a good profit.
When transferring mortgage to a buyer, there will be a higher interest rate than your new mortgage would have. This can make wraparound mortgages profitable for sellers.
Let’s take a wraparound mortgage example:
Suppose you get a new mortgage with an interest rate of 5% whereas the mortgage your buyer receives has a rate of 7%. This can lead to you keeping the 2% difference in your pocket.
Moreover, whatever your buyer pays for your remaining mortgage will automatically become profit for you. For example, if you had a $100,000 mortgage that was remaining on your old house and the buyer is paying a $250,000 mortgage when buying the house from you, the difference of $150,000 between your remaining mortgage and the buyer’s mortgage will be profit for you.
Because wraparound mortgages come with the potential to make money, people who are looking to invest in real estate choose this option.
2. When a buyer cannot secure a traditional mortgage.
If a buyer does not have the necessary credit in order to secure a mortgage from a traditional lender, the only other alternative that can be a good option is a wraparound mortgage. Especially if in a slow housing market as lenders normally become more strict about who they would like to lend to. If you are selling in a slow market, it is possible that you lose buyers only because other lenders are being so strict.
Risks With a Wraparound Mortgage
Even though a wraparound mortgage can be a good decision for both sellers and buyers, there is still some risk attached to it.
One of the biggest risks with a wraparound mortgage is that the lender of the original mortgage can trigger a due-on-sale clause.
This is a clause conventional mortgages typically have that allows the lender to request for the remaining mortgage when a house is sold. If your remaining mortgage balance is $100,000 and you want to secure a wraparound loan, you will be asked for the $100,000 by your original mortgage lender once you sell the house. The lender will take possession of the house if you are not able to make the full payment.
Risks for the seller
Since you are taking on the role of a mortgage lender, you also have to deal with the risks of a lender. If the buyer is not making their payments, you will have difficulty in paying for your old house and as a result, for the new one as well. In case you cannot get the payments, you would have to foreclose the properties.
Risks for the buyer
The risk for the buyer is trusting the seller to make the payments on the new mortgage. When you get a wraparound mortgage, the payments you make are used to pay off the original house’s mortgage first. So if for some reason, you stop making the payments, the old property might end up going to foreclosure before the new one does. This might end up leaving the buyer without a home even if they have been consistent in their payments.
The Bottom Line
The bottom line is, when getting a wraparound mortgage, it is important to make sure you fully understand the risks and responsibilities it comes with. Whether you are a buyer or a seller, they will both have their own sets of risks and responsibility.
So knowing what is a wraparound mortgage is not enough, you have to understand and be prepared to take on the risks as well. To know more about your property and the mortgage loan you can borrow, you should talk to a real estate attorney.