Wraparound Mortgages

• Wraparound mortgages function as a type of seller-based financing when selling a home. A seller who has an existing mortgage on a home he wishes to sell can package his existing mortgage loan inside a new mortgage loan taken out by a buyer. An example of this would be a seller with an $80,000 home and a remaining mortgage balance of $40,000. A potential buyer puts $5,000 down and takes out a mortgage loan for $75,000. In effect, the new loan taken out by the buyer "wraps around" the seller's existing mortgage loan so the buyer ends up making payments toward the existing $40,000 mortgage on the home.
  
  

Principal Reduction

• Wraparound mortgages place sellers in an advantageous position when it comes to paying off the remaining principal loan amount on an existing mortgage. Ultimately, the amount of interest attached to a loan determines the rate at which the principal is paid off. With a wraparound mortgage, the seller earns interest monies on the new mortgage loan from the payments made by the buyer. For example, if an existing $40,000 mortgage balance carries an interest rate of 5 percent and the new $75,000 loan carries an interest rate of 7 percent, the seller profits from the 7 percent interest cost paid as well as from the difference between the 5 and 7 percent interest rate on the existing $40,000 mortgage balance. In effect, a portion of the interest payments made toward the wraparound mortgage is applied toward the seller's existing mortgage balance of $40,000, which pays off the principal loan amount sooner.
  
  

Loan Conditions

• With a wraparound mortgage agreement, the borrower makes payments to the bank or mortgage company that financed the wraparound mortgage. This mortgage company is responsible for paying off the bank that financed the seller's existing mortgage. Each of the borrower's monthly payments includes the principal and interest owed on the new mortgage loan amount; however, part of the borrower's monthly payment includes the principal and interest due on the original or existing mortgage loan. From the seller's standpoint, the older the original mortgage loan, the quicker the seller pays down or reduces the principal loan amount on the existing mortgage. In effect, the older the mortgage, the less the seller pays in interest costs toward the loan. This means more of the monthly mortgage payment goes toward paying down the principal amount.
  
  

Risks

• The benefits sellers reap when entering a wraparound mortgage agreement can turn into risks or losses in cases where a buyer defaults on the loan. Prior to the agreement, the seller has a certain amount of equity in the home after so many years of paying on the existing mortgage. Once he enters into a wraparound agreement, the seller's equity equals the amount of the down payment provided by the buyer. In effect, any existing equity is converted into a mortgage loan debt. And while the seller no longer owns the home, the mortgage responsibility falls back on the seller if the buyer defaults on the loan. As a result, the seller is left with a new mortgage loan debt that's larger than the one he originally had.