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Wraparound Mortgage
A wraparound mortgage is a financing arrangement between buyer and seller whereby the buyer executes an installment note (wraparound note) which "wraps around"  an existing mortgage still held by the seller.  More simply,  it is a type of financing where the seller carries a portion of the buyerís loan. 
 

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  It facilitates a sale by blending an existing mortgage held by the seller and a new mortgage (seller financing) granted by the seller.  The difference between the existing mortgage still owed by the seller and the sale price (less any required down payment by the seller), is termed "real debt."  The seller is the wraparound note "holder" and the buyer becomes the wraparound note "maker."

Title to the real property is accepted by the buyer subject to the lien(s) securing the underlying note and the maker (buyer) usually does not assume the indebtedness of the seller's original loan. The lien securing payment of the wraparound note is subordinate (inferior) to the original loan still held by the seller.

Generally, the wraparound note provides that the holder (seller) shall, subject to the performance of the maker (buyer) under the wraparound note, pay to the underlying note holder the current installment of principal and interest due on the underlying note. 

Advantages

Seller Perspective

  • Seller can increase the effective rate of return on his/her equity
  • Parties can avoid acceleration of the underlying note upon sale of the property
  • Seller may be able to take an advantageous position for federal income tax purposes when reporting a gain on the installment sale method.  This cannot usually be achieved by the buyer's simply assuming or accepting title to real property "subject to" an underlying note
  • Can expedite a quick closing

Buyer Perspective

  • Ideal for people who have less-than-perfect credit
  • It is a way to finance a purchase without the hassle of going through a lender to qualify or having to pay closing costs
  • The buyer simply pays seller one payment to cover [1] the payment on the existing mortgage and, [2] the amount necessary to cover the balance of the purchase price

How Does A Wraparound Work?

  1. Establish a sale price and write the offer.  To determine the amount of the wraparound mortgage, deduct your down payment from the purchase price. (The seller must be willing to accept your monthly payments over a period of years instead of a lump sum for a wraparound to work).
  2. Agree upon an interest rate.  Typically, the interest rate will be near that charged by conventional lenders - a "market" rate so to speak, but it may be slightly higher to compensate the seller for his/her financial assistance. The seller will likely require a copy the buyer's credit report.
  3. Obtain a copy of the note on the seller's existing loan.   Read the existing loan documents to ensure that doing a wraparound will not trigger a "due-on-sale" clause which requires the loan to be paid off when the home is sold. Further, if you wrap a mortgage and fail to notify the lender, the lender may "call" the entire loan amount due.  Payments on the wraparound mortgage will need to be structured around the terms of the existing first mortgage.  You can still wrap an adjustable-rate first mortgage but fixed rate mortgages are easier to calculate a payment schedule. If the existing first mortgage has an adjustable rate and payments have increased, the wraparound payment should change to compensate for the increase in payment. If the first mortgage payment decreases because of a favorable rate change, it is easier to leave the overall payment the same and apply any additional money toward the balance.  The seller pockets any difference in payments after the existing loan is paid. 
  4. Open an escrow account with a title company or hire a real estate attorney to handle the transaction.
  5. Arrange a closing date. Project the exact balance owed on the first mortgage as of the closing date and calculate the required payment necessary to "amortize" both the first mortgage payment and the new wraparound mortgage payment. The attorney or escrow officer will usually calculate this information.
  6. Keep a good record of payments after the closing.  Wraparound mortgages are complex and can involve multiple liens.  A seller must keep good track of payments including how much of each payment applies to interest and principal on both the first and wraparound mortgages.  The seller must provide a form to the Internal Revenue Service reporting the amount of interest paid on a seller-financed mortgage. 
  7. Buyers should request copies of payment receipts from the seller for each payment the seller makes on the first mortgage.  A buyer could lose the house in foreclosure even if he/she has made all the payments.  If the seller fails to make payments to the original lender, the buyer could get into trouble. It is prudent to obtains copies of payment receipts or the ending (year-to-date) statement on the first mortgage to see exactly how much has been paid off. In most cases, in the event of default by the holder (seller) on the underlying note, the maker (buyer) is allowed to cure the default and reduce his obligation under the wraparound note subject to the original lender agreement. 
  8. Buyer should request proof that insurance and taxes are being paid.  

Caveat

Wraparound mortgages are not legal in all states and some lenders will not allow their loans to be wrapped. This type financing is not very common since most mortgages have a due-on-sale clause. Wraparound mortgages may also be referred to as all-inclusive trust deeds (AITD).

Due-on-Sale Clause

Lenders include a due-on-sale clause in a mortgage to prevent buyers from taking over a sellerís existing mortgage. It gives them the right to demand repayment of the entire loan when the property is sold.  The existing mortgage usually has a lower interest rate than current market rates and lenders donít benefit when this occurs.  A due-on-sale clause is a form of acceleration clause.

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