- Wraparound mortgages are a common form of seller financing in which the owner of a piece of property extends a loan to a new buyer instead of having the buyer assume the existing mortgage. The new junior mortgage that results "wraps around" the senior mortgage, with the seller using the proceeds of the junior mortgage to continue making payments on the senior debt. The principal on a wraparound mortgage is usually equal to the amount outstanding on the senior mortgage plus any remaining balance from the sale amount less down payment. A wraparound mortgage usually involves transfer of title to the new buyer with the seller able to foreclose on the property if necessary.
- Because wraparound mortgages are seller financed instead of using a financial institution, there is an immediate savings on closing costs. It also prevents a buyer from having to qualify for a loan under the more restrictive requirements of most lending institutions. From the seller's perspective, it is even more beneficial--not only can a wraparound mortgage expedite a sale, it can help them make a larger profit by charging a higher interest rate on the junior mortgage than what they owe on the senior mortgage. This interest rate arbitrage is called a "middle" and represents additional profit over and above any appreciation in the property's sale price. There might also be federal income tax advantages to receiving payments in installments.
- Most primary mortgages issued through a lender include a "due-on-sale" clause that makes the full balance on a senior mortgage due upon transfer of title. This would leave the seller in the position of having to satisfy the senior mortgage in cash while collecting the junior mortgage over time, defeating the wraparound benefit. The buyer could lose title to the house if the holder of the senior mortgage is forced to foreclose. In most cases, though, this clause creates a right to call in the mortgage, not an obligation, and is not always an obstacle to a wraparound mortgage. Sellers, however, are subject to credit risk associated with their new buyers as well as to the interest rate environment, which should ideally be equal to or higher than the rate of the senior mortgage. Wraparound mortgages are not permissible in all states, so a seller should check their local laws in addition to contacting the holder of their primary mortgage.
