A wrap-around mortgage is a type of loan where a borrower takes out a second mortgage to help guarantee payments on their original mortgage. The borrower will make payments on both of the mortgages to the new lender, who is called the “wrap-around” lender. The wrap-around lender will then make the payments to the original mortgage lender.
This can allow the borrower to obtain a loan at a lower interest rate than if they had gotten a completely new loan. Once they have secured the wraparound loan as security for the original mortgage, the borrower may be able to avoid certain measures like foreclosure. The wrap-around mortgage is an example of creative financing.
What Are the Wrap-Around Mortgage Benefits?
Wrap-around loans can be attractive to the borrower because it can result in an interest rate that is lower than market prices, though still a bit higher than the original loan.
- Buyer’s Benefits: If the buyer does not have good credit and would not qualify for a traditional mortgage loan, the buyer can use a wraparound mortgage instead. The buyer also does not have to pay any closing cost fees with a wraparound mortgage.
- Seller’s Benefits: During hard times such as a recessions, sellers do not have many buyers who qualify for a traditional mortgage.
What Are the Wrap-Around Mortgage Disadvantages?
Disadvantages to wrap-around mortgages include:
- Defaults: A major risk is that buyers could fail to make payments on the wraparound mortgages and the seller would be unable to pay the original mortgage. This would result in foreclosure of the seller's home.
- Seller Failure to Make Payments: If the buyer makes payments to the seller on the wraparound mortgage, but the seller does not use the funds to pay the original mortgage payments, the lender can still foreclose on the home since the title remains in the seller’s name.
- Due-on-Sale Risk: Mortgages typically have due-on-sale clauses, which gives the lender the right to ask for the entire loan and demand repayment of the loan in full once the home is sold. A wraparound mortgage can fall apart if the lender decides to exercise the due-on-sale provision.
Are Wrap-Around Mortgages the Same as a Second Mortgage?
Not exactly. With a second mortgage, the old mortgage is generally repaid. On the other hand, with a wrap around mortgage, the original mortgage is still active, and the borrower begins making payments for both the old mortgage and the new one, to the new lender.
Both wrap-around mortgages and second mortgages can be a form of “seller financing”, which means that the lender is also the seller. However, as mentioned, the old mortgage usually needs to be paid off before the borrower can take out a second mortgage.
Are Wrap-Around Mortgages Legal?
Yes, wrap-around mortgages are generally held to be legal. However, their use in the real estate market has dwindled in recent years due to several factors. One of the main concerns involves the increased use of “due on sale” clauses in many mortgage agreements.
A due-on-sale clause basically requires the borrower to pay the entire balance of a loan whenever the property has sold. This makes it much more difficult to arrange for a wrap-around mortgage, and instead the borrower must usually take out a second mortgage in the manner mentioned above.
However, there are a few limited situations where the lender doesn’t use these clauses, or when the due on sale clause isn’t enforceable. These types of exceptions may be complicated and can require the assistance of real estate attorney.
Should I Hire a Real Estate Lawyer?
Wrap-around mortgages can often eliminate some of the barriers to home loan approval and can make the process of purchasing a home much quicker. However, they can give rise to legal disputes, such as when the lender and the borrower have a conflict over loan repayment clauses. You may wish to contact an experienced real estate lawyer in your area if you need help with a wrap-around mortgage. Your attorney can advise you on your legal options, and can represent you during court hearings if needed.