A wrap-around loan allows a person to buy a home without having to receive a mortgage by a lender like a bank or credit union. Rather, the seller of the home acts as the creditor. Wrap-around mortgages can help buyers with bad credit and sellers who can not get rid of their homes, but they carry risks for both sides.
Basics
In a typical home sale, the purchaser obtains a mortgage and uses that money to pay the seller. The seller takes the money, pays off anything he owes on his mortgage and pockets the remainder as profit. In a wrap-around deal, the seller’s mortgage remains in place, and he creates another mortgage to the buyer, at a higher rate of interest than the one in his mortgage. That instant mortgage”wraps around” the very first, thus the name. The purchaser takes possession of the home and makes monthly payments to the seller; the seller utilizes some of that money to pay his own monthly mortgage bill and pockets whatever is left over as profit.
Example
Say a seller has a home valued at $400,000, and he owes $250,000 on his mortgage at 6 per cent interest. His payment is about $1,500 a month. He sets up a wraparound deal with a purchaser, who’ll put $20,000 down and finance the remainder at 7% interest. Each month, the purchaser sends the seller a check based on a $380,000 loan at 7% interest. That’s about $2,500 a month. So the seller pockets the 1,000 makes his own payment. In effect, the seller is earning the difference between 6% and 7% on the first $250,000 of their mortgage, and the full 7 percent on the next $130,000.
Benefits
For buyers who cannot get qualified for a regular mortgagebecause of terrible credit, for instance –a wrap-around could be a route to homeownership. When interest rates have increased considerably since the seller took out the original mortgage, a wrap-around may enable the purchaser to”piggy-back” on that lower speed –paying 7%, for instance, once the market rate would actually be 8 percent. For prospective sellers stuck in a bad housing market, a wrap-around may be their very best opportunity to unload the home.
Buyer/Seller Hazards
A wrap-around mortgage relies largely on trust. The purchaser can faithfully send her obligations every month, but if the seller doesn’t use them to pay the original mortgagethen his lender will foreclose on the home, and the purchaser will likely have lost her money and her home. On the reverse side, if the purchaser quits paying, the seller may have to foreclose on her behalf before his own creditor forecloses on him.
Due-on-Sale Risk
Mortgages typically possess a provision known as”due on sale,” that gives the creditor the right to”call” the entire loan–which is, demand repayment in full–if the residence is sold. A wrap-around arrangement can come instantly in the event the seller’s creditor exercises this option.