A wraparound mortgage is a type of financing tool used in real estate transactions. This form of financing arrangement is an alternative to traditional mortgages and is often utilized when a seller finances the purchase for the buyer.
Here’s how it works:
- Seller Financing: The seller extends to the buyer a junior mortgage that wraps around and exists in addition to any superior mortgages already secured by the property. In simpler terms, the seller is lending the buyer the money to buy the property.
- Payments: The buyer makes monthly payments to the seller, who then uses part of those payments to maintain any old mortgage and keeps the rest as profit.
- Interest Rates: The interest rate on a wraparound mortgage is typically higher than the original loan’s rate, which allows the seller to earn a spread between the rate they pay and the rate they charge the buyer.
- Transfer of Ownership: Although the buyer holds equitable title to the property, legal title remains with the seller until the wraparound mortgage is paid off.
- Risks and Benefits: For the buyer, this method can make financing easier to obtain, though at a higher cost. For the seller, it provides a steady income stream at a potentially higher interest rate than they are paying on their mortgage. However, it also carries risks for both parties, especially if the original mortgage has a due-on-sale clause, which could require the full balance to be paid upon transfer of ownership.
- Use in Real Estate Investment: In the real estate investment industry, wraparound mortgages can be a useful tool for investors who are looking to sell properties quickly or who wish to make a profit on the financing as well as the sale of the property. It can also be advantageous for investors purchasing a property, as it may allow them to obtain financing when traditional mortgages are not an option.
Wraparound mortgages are complex financial instruments that involve significant legal and financial considerations. They are not permitted in all states and typically require the services of a real estate attorney to execute properly. It’s important for both buyers and sellers to fully understand the terms and potential consequences of such an arrangement.