Wraparound mortgages, also known as wrap loans or all-inclusive trust deeds, are a unique and versatile financing option in the realm of real estate. This financial instrument is gaining popularity for its flexibility and ability to facilitate transactions that might be challenging through traditional mortgage arrangements. In this article, we will explore the ins and outs of wraparound mortgages, including their definition, structure, benefits, and potential risks.
Understanding Wraparound Mortgages:
A wraparound mortgage is a secondary financing option where a new mortgage encompasses the existing mortgage on the property. In simpler terms, the new lender assumes the responsibility of the old mortgage while creating a new, “wraparound” loan. This arrangement allows the borrower to make payments to the new lender, who, in turn, continues to pay the existing mortgage.
Structure of Wraparound Mortgages:
1. Principal Wraparound Mortgage (First Position): In this scenario, the new loan amount is higher than the existing mortgage, covering the outstanding balance of the original loan and providing additional financing to the borrower. The borrower makes monthly payments to the new lender, who then distributes the appropriate portions to the original mortgage holder.
2. Junior Wraparound Mortgage (Second Position): Conversely, a wraparound mortgage can also be structured as a subordinate loan. The new lender provides additional financing to the borrower, but the original mortgage remains in the first position. This means that the borrower makes payments to the new lender, who in turn pays the original mortgage, with any excess going toward the subordinate loan.
Benefits of Wraparound Mortgages:
1. Flexibility: Wraparound mortgages offer flexibility in financing, allowing buyers and sellers to negotiate terms that may not be possible with traditional lenders. This can be particularly advantageous in a buyer’s market or when dealing with unique properties.
2. Avoiding Due-on-Sale Clauses: Since the original mortgage remains in place, wraparound mortgages can be a way to avoid triggering a due-on-sale clause, which is a provision in some mortgages that allows the lender to demand full repayment if the property is sold.
3. Attractive Financing for Buyers: Buyers who might face challenges in obtaining traditional financing can find wraparound mortgages appealing. This includes those with less-than-perfect credit or those unable to meet stringent bank requirements.
Risks and Considerations:
1. Default Risk: If the borrower defaults on the wraparound mortgage, the new lender may be responsible for the payments on the existing mortgage. This can pose a risk, especially if the new lender does not have the financial means to cover the payments.
2. Due Diligence: Both parties involved in a wraparound mortgage need to conduct thorough due diligence. Sellers should ensure the buyer has the financial capacity to make payments, and buyers must assess the existing mortgage terms and the financial stability of the seller.
3. Consent of the Original Lender: It’s essential to review the original mortgage agreement, as some lenders may require consent before a wraparound mortgage can be implemented.
Wraparound mortgages provide a creative financing solution for real estate transactions, offering flexibility and opportunities for both buyers and sellers. However, as with any financial arrangement, it’s crucial for all parties involved to conduct thorough research, understand the risks, and seek professional advice when considering or entering into a wraparound mortgage. When used judiciously, wraparound mortgages can be a valuable tool in the diverse landscape of real estate financing.
