Wraparound Mortgages Explained: Everything You Need To Know

When a buyer can’t qualify for a traditional mortgage loan, it can make for a rough sale for both the buyer and seller. While the situation may seem impossible, there may be another financing option for both parties to close the deal.

A wraparound mortgage can provide the buyer with the financing they need to purchase a home, and it may even make the seller a profit. However, wraparound mortgages come with risks, so it’s important to know what you’re getting into before using one to buy or sell a home.

What Is A Wraparound Mortgage?

A wraparound mortgage is a home loan that allows the seller to maintain their existing mortgage while the buyer’s mortgage “wraps” around the existing amount owed.

Instead of paying a bank or lender, the buyer makes monthly payments directly to the seller. In turn, the seller uses a portion of the buyer’s monthly payments to continue making their mortgage payments. Since most wraparound mortgages often have higher interest rates than conventional mortgages, sellers can typically profit from the rate they charge a buyer.

How Does A Wraparound Mortgage Work?

In a typical real estate transaction, a buyer purchases a home with a mortgage issued by a mortgage lender. The seller then uses the proceeds from the sale to pay off their existing mortgage.

With a wraparound mortgage, the seller keeps the existing mortgage on the home. They offer seller financing to help the buyer complete the purchase and then wrap the buyer’s new loan over their existing mortgage. In this situation, the seller takes on the role of the lender.

The buyer and seller agree to a down payment and loan amount, then sign a promissory note laying out the mortgage’s terms.

After both parties finalize the transaction, the seller transfers the title and deed to the buyer. While the seller continues to make payments on the original mortgage, they no longer own the home.

For a wraparound mortgage to work, the seller’s mortgage must be an assumable mortgage. If not, the seller’s lender may see a wraparound agreement as a violation of the original loan terms.

The wraparound mortgage takes the second or junior lien position, while the seller’s mortgage remains in the first lien position. If the buyer fails to make their monthly payments and the default results in foreclosure, the seller’s lender will get repaid first from the sale of the home. As the junior lien “lender,” the seller will receive any leftover funds after the original lender is fully repaid.

Wraparound Mortgage Example

Here’s an example of how a wraparound mortgage works:

Sam is selling a home for $160,000 and has an existing mortgage balance of $40,000 at a 4% fixed interest rate. Sam decides to finance a loan for Alex (the buyer) to purchase the home. Sam and Alex agree to a $10,000 down payment and $150,000 wraparound mortgage at a 6% fixed interest rate.

Alex pays Sam every month, and Sam uses the funds to continue paying off the original mortgage and pockets the difference between the two payments. Sam can make a healthy profit thanks to the 2% difference in interest rates.

Wraparound Mortgage Pros And Cons

While a wraparound mortgage can benefit sellers and buyers, there are risks each party should consider before proceeding.

Both parties should consider working with an experienced real estate attorney to guide them through the process and reduce everyone’s risk.

Benefits For Buyers

• Easier to qualify: It can be easier for home buyers to qualify for wraparound loans because they typically have more flexible requirements.
• Potential for lower closing costs: Since buyers work directly with sellers, they may be able to avoid some fees a traditional lender would likely charge.

Benefits For Sellers

• Profit potential: By charging a higher interest rate, sellers can profit from the difference between the rate on their existing mortgage loan and the buyer's new rate.
• Larger pool of buyers: For sellers finding it difficult to sell their homes, seller financing offers the opportunity to reach more buyers.

Risks For Buyers

• Higher interest rates: Since the seller determines the rate, wraparound mortgages typically have higher interest rates than traditional mortgages.
• Risk of foreclosure: The seller’s original lender can foreclose on the property if the seller stops making payments and defaults on their existing mortgage – even if the buyer makes on-time monthly payments to the seller.

To help prevent foreclosure and potentially losing the home, buyers should consider including a clause in the wraparound agreement that allows them to make their monthly payments directly to the seller’s original lender.

Risks For Sellers

• Lender approval: When a mortgage loan isn’t assumable, most lenders require full repayment once a home gets sold or changes ownership. A wraparound mortgage can’t happen if the loan isn’t assumable, or if your lender doesn’t approve the arrangement.
• Assuming lender responsibilities: To ensure the existing mortgage gets paid, sellers must focus on collecting payments from buyers each month.
• Risk of foreclosure: If the buyer stops making payments, the seller must cover their original mortgage payment or risk mortgage default.

Alternatives To Wraparound Financing

If you’re a buyer having trouble qualifying for a conventional loan, there may be other types of mortgage loans that can help, such as:

• FHA loans: Federal Housing Administration loans can be a valuable financing option for qualified home buyers with lower credit scores or limited funds for closing costs. FHA loans have lower down payment and credit score requirements and often allow borrowers to roll closing costs into the loan, reducing what they pay upfront.
• VA loans: Department of Veterans Affairs loans are available to qualified active-duty service members, veterans and surviving spouses. Borrowers typically don’t make a down payment. VA loans feature competitive interest rates and don’t require private mortgage insurance (PMI).
• USDA loans: U.S. Department of Agriculture loans are available in qualifying rural areas. USDA loans typically don’t require a down payment. They also offer low interest rates. Rocket Mortgage® doesn’t offer USDA loans at this time.

The Bottom Line: Wraparound Mortgages Come With Risks

In a wraparound mortgage situation, the buyer gets their mortgage from the seller, who wraps it around their existing mortgage loan. The buyer owns the home and makes their monthly mortgage payments – with interest – directly to the seller. The seller uses the buyer’s payment to continue paying off their mortgage to the original lender.

While a wraparound mortgage is a creative financing approach that can help a buyer who can’t qualify for a traditional mortgage or a seller who wants to attract more potential buyers, it involves several risks. To help reduce the risks, the buyer and seller should work with an experienced real estate attorney.

Looking for a more traditional mortgage option? Start a mortgage application today with Rocket Mortgage and begin your home buying journey.