What Is a Wrap-Around Loan?
Let me explain what a wrap-around loan is—it's a type of mortgage used in owner-financing situations. In this setup, the loan wraps around the seller's existing mortgage on the property, adding extra value to reach the total purchase price that you, as the buyer, pay to the seller over time instead of directly to a lender. This can help if you don't qualify for a traditional mortgage, and it gives the seller a chance to make some profit.
Key Takeaways
A wrap-around loan is essentially owner-financing where the seller keeps their first mortgage, and you repay part of it through your new agreement with them. You sign a mortgage directly with the seller instead of going to a bank, and this new loan helps pay off the seller's existing one. Keep in mind, these loans are risky because the seller bears the full default risk for both loans.
Understanding Wrap-Around Loans
Seller financing means you pay the principal directly to the seller based on a promissory note that outlines the terms—no upfront principal exchange, just installment payments including principal and interest. Wrap-around loans build on this by factoring in the seller's remaining mortgage balance when they still owe on the property's first loan.
In a wrap-around loan, we account for that remaining balance at its original rate and add an incremental amount to get to the full purchase price. You sign a promissory note to make monthly payments to the seller, and the title and deed transfer to you. The seller keeps paying their existing mortgage.
The seller's base interest rate comes from their original loan terms. To break even, they need to earn at least that much interest, but they can negotiate a higher rate with you to cover their payments and pocket a spread. Typically, sellers aim for the highest rate possible to profit from the deal.
Fast Fact
Seller financing deals are high-risk for sellers, so they often require higher-than-average down payments from you.
Risks of Wrap-Around Loans
These loans can be risky for sellers because they take on all the default risk. You need to ensure your existing mortgage doesn't have an alienation clause, which forces full repayment if the property is sold or transferred—common in most mortgages, and it can block wrap-around deals.
For you as the buyer, risks include paying a higher interest rate than a traditional mortgage. If the original loan isn't assumable, the lender might foreclose and take the home.
Example of a Wrap-Around Loan
Consider this hypothetical: Joyce has an $80,000 mortgage at 4% interest. She sells to Brian for $120,000; he puts 10% down and borrows $108,000 at 7%. Joyce earns 7% on the $28,000 difference, plus 3% (the spread between 7% and 4%) on the $80,000 balance.
Who Issues a Wrap-Around Loan?
The property seller issues it, not a bank. You promise payments to the seller, who then pays their lender. This lets the seller pay off their loan while profiting from a higher rate charged to you.
What Are the Benefits of a Wrap-Around Loan?
Sellers profit if they charge you more interest than their original rate. For you, it's flexible and easier to qualify. Both sides save on expenses like closing costs since you're dealing directly.
What Is Seller Financing?
It's financing where the seller handles the mortgage instead of a bank. You take out the loan with the seller, useful if you can't get traditional financing. Often, there are low or no closing costs or down payments, and sellers profit from higher interest.
The Bottom Line
Wrap-around loans simplify deals between buyers and sellers by cutting out banks—you pay the seller monthly. They can be favorable with profit for sellers and easy qualification for you, but watch for risks like high rates and default possibilities.
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