A mortgage is a security interest that is attached to a piece property, and is paid for with borrowed money. This security interest acts as collateral for the repayment of a loan that was borrowed in order to pay for the property. An example of this would be when a person wants to buy a house, and they do not have enough of their own money to purchase the house outright.
A bank or other lender will provide the money, and a mortgage is placed on the property. If the borrower defaults on their loan, the lender has the legal right to take possession of that property so that they can attempt to reclaim some of the lost money. A mortgage serves as a sort of lien on the property.
A second mortgage is a mortgage loan secured by real estate that already has a mortgage attached to it. “Second” mortgages are referred to as such because of where it is in line to be paid in case of foreclosure. During foreclosure proceedings, liens on the property are paid off in order of seniority. As the first mortgage on the property will be paid off first, the second mortgage will be paid off after the first mortgage.
First mortgages use the property as collateral for the loan, while second mortgages often involve borrowing against the equity in the home. Equity is calculated by the loan to value ratio; or, the difference between the market value of the home, and what is currently owed on the home.
A wraparound mortgage is a specific type of loan in which a borrower takes out a second mortgage in order to help guarantee payments on their original mortgage. The borrower makes payments on both of the mortgages to the new lender, who is referred to as the “wraparound” lender. The wraparound lender makes the payments to the original mortgage lender.
The purpose of a wraparound mortgage is that the borrower can obtain a loan at a lower interest rate than if they had obtained an entirely new loan. Once the wraparound loan has been secured as a type of security for the original mortgage, the borrower may avoid certain measures, such as foreclosure. Wraparound mortgages are considered to be an example of creative financing.
What Are Some Advantages and Disadvantages of Wrap-Around Mortgages?
There are some notable advantages to wraparound loans, which can make them attractive to the borrower. This is because such creative financing can result in an interest rate that is lower than market prices. However, this interest rate would still be slightly higher than the original loan.
- Buyer’s Benefits: If the buyer has poor credit, and would not qualify for a traditional mortgage loan because of that, they can use a wraparound mortgage instead. Additionally, the buyer does not have to pay any closing cost fees when using a wraparound mortgage.
- Seller’s Benefits: The main benefit for sellers would occur during something such as an economic recession. During difficult economic times, such as recessions, sellers do not have many buyers who qualify for a traditional mortgage. A wraparound mortgage allows sellers to consider a wider variety of qualified buyers, thereby reducing the impact of the economic hardship.
It is important to note that there are some disadvantages related to wraparound mortgages. Some of the most common examples of disadvantages to wraparound mortgages include:
- Defaults: This is considered to be a major risk, because buyers could fail to make payments on the wraparound mortgages. In such cases, the seller would be unable to pay the original mortgage, which would result in foreclosure of the seller’s home;
- Seller Failure to Make Payments: There are instances in which the lender can still foreclose on the home. An example of this would be if the buyer makes payments to the seller on the wraparound mortgage, but the seller does not use those funds to pay the original mortgage payments. The lender could still foreclose on the home because the property’s title remains in the seller’s name; and/or
- Due-On-Sale Risk: Generally speaking, mortgages contain due-on-sale clauses. These clauses give the lender the right to ask for the entire loan, and demand repayment of the loan in full once the home has been sold. A wraparound mortgage would be especially vulnerable to falling apart if the lender decides to exercise the due-on-sale provision.
Are Wraparound Mortgages the Same As Second Mortgages?
Although they are similar, wraparound mortgages are not the same as second mortgages. It is helpful to further discuss what a second mortgage is, before further discussing how it differs from a wraparound mortgage.
People may use the funds from the second mortgage to pay off credit card debt, or other types of debts. Doing so allows them to save money, due to the fact that the second mortgage often has a lower interest rate than credit card rates. Homeowners may take out a second mortgage in order to finance home improvements, such as renovations. Or, they may do so to obtain additional financing for business loans.
Some people include a second mortgage as part of their home buying process. This is done in order to avoid private mortgage insurance, which is sometimes called PMI. Depending on each individual lender’s requirements, the second mortgage could “piggyback” on the first mortgage in order to make a sufficient down payment on the home, that does not require PMI.
It is important to note that the interest rates for second mortgages are generally higher than those for first mortgages. Additionally, the amount borrowed will generally be lower than the first mortgage.
The old mortgage is generally repaid with a second mortgage. A wraparound mortgage keeps the original mortgage still active, and the borrower makes payments to the new lender for both the old mortgage and the new one.
Both wraparound mortgages and second mortgages can be considered a form of “seller financing.” What this means is that the lender is also the seller. However, as previously mentioned, the old mortgage generally must be paid off before the borrower can take out a second mortgage.
Are Wraparound Mortgages Legal?
Wraparound mortgages are generally considered to be legal. However, they are less commonly used in the real estate market due to several factors. One of these considerable factors is the increased inclusion of “due on sale” clauses in many mortgage agreements.
As previously mentioned, a due-on-sale clause essentially requires the borrower to pay the entire balance of a loan whenever the property has been sold. This makes it more difficult to arrange for a wraparound mortgage. Instead, the borrower would most likely need to take out a second mortgage.
However, there are some limited situations in which the lender does not use a due-on-sale clause, or when the clause is not enforceable. Such exceptions are infrequent and complicated, and would require the counsel of an attorney.
Do I Need An Attorney For Issues With a Wraparound Mortgage?
Wraparound mortgages can be considerably complex and difficult to both understand and obtain. If you are considering obtaining a wraparound mortgage, or have obtained one and are experiencing issues associated with it, you should consult with an experienced and local mortgage lawyer.
A mortgage attorney will be best suited to helping you understand how your state addresses such mortgages, and what you should be aware of moving forward. Additionally, an attorney will also be able to represent you in court, as needed, should any legal disputes arise.