- A wraparound mortgage is a type of seller financing in which the seller of the property has an existing mortgage on the property and the buyer assumes this mortgage and only has to obtain a new mortgage for the difference between the purchase price and the existing mortgage. It benefits the seller because he can sell the home. It benefits the buyer because she can buy the home without having to obtain a mortgage for the full amount. For the lender, the transaction brings in more income.
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Typically, the seller in a wraparound mortgage transaction is the mortgage lender. In this situation, the lender can increase its yield because it is collecting payments on the first and second mortgage. While the interest rate of the first mortgage is established already, the second mortgage that wraps around the first mortgage typically has a higher interest rate. This means that the lender is increasing its yield.
For example, Mr. Smith sells a home to Mr. Ford for $150,000 and Mr. Smith has an existing mortgage balance of $90,000. Mr. Ford gives Mr. Smith a down payment of $5,000 and establishes a wraparound mortgage for the remaining $55,000. The interest rate on the first mortgage is six percent and the interest rate on the new second mortgage is eight percent. When the wraparound mortgage is established, the lender only has to lend $55,000 to the buyer on which it will earn the eight percent, but the lender also earns the difference between the two interest rates on the $55,000 wraparound mortgage. - To make a wraparound mortgage transaction possible, the first mortgage has to be assumable by the buyer. An assumable loan is a mortgage in which the existing borrower (the seller) can transfer his debt obligation (the mortgage) to the buyer. While assumable loans were more prevalent in the past, you usually only see an assumable clause option offered with FHA and VA loans. If there isn't an assumable clause with the first mortgage, the seller has to obtain permission from the lender to do a wraparound mortgage. If there is an assumable clause, then paperwork is filed with the lender in order to transfer the debt obligation of the first mortgage from the seller to the buyer.
- The buyer of the home has the option of financing the second mortgage with the existing lender. This is probably the easiest way to obtain a second mortgage since the lender also holds the first mortgage. Because second mortgages are riskier to the lender (because they are second in line to be paid in case of default by the borrower), they can be harder to obtain.
- The other option for obtaining the second mortgage is for the buyer to apply with a different lender than the one who holds the first mortgage. There are two paths a borrower can take with the new lender. On one path, the second mortgage lender pays off the first mortgage lender and then holds one mortgage for the total amount. The other path is that the second mortgage lender holds the second mortgage and the first mortgage remains as is.
