Last updated on October 16th, 2024 at 10:34 pm

Last Updated on October 16, 2024 by

Have you heard of a “wrap-around mortgage?” There are other terms for the same type of mortgage but the meaning is that a buyer can come to a buyer with some down payment cash and take over an existing mortgage. There is more to this but the concept works. Wrap-around mortgages are not for everyone. There are some risks for the seller and buyer. Generally this type of mortgage comes back to the market when interest rates are high and the debt to income ratios are out of line.

Advantages of Wrap-Around Mortgages:

• Lower Interest Rates: In certain market conditions, the seller may offer a lower interest rate than what is available from traditional lenders.
• Faster Closing: The process can be faster as there is no need for a new appraisal or underwriting.
• Seller Financing: Can be a solution for buyers who cannot qualify for traditional financing.

Disadvantages of Wrap-Around Mortgages:

• Higher Risk for Sellers: Sellers bear the risk of the borrower defaulting on the loan.
• Limited Flexibility: The terms of the loan are negotiated between the seller and buyer, providing less flexibility compared to traditional loans.
• Potential for Interest Rate Risk: If interest rates rise, the seller may be at a disadvantage.

In conclusion, wrap-around mortgages can be a viable option for buyers and sellers in certain circumstances. However, it’s crucial to carefully consider the risks and benefits before entering into such an agreement. Consulting with a qualified real estate attorney or financial advisor is recommended to ensure a thorough understanding of the terms and potential implications.

How do I get more information about this type of mortgage?

Wrap-around mortgages are not traditional which means that your loan broker will not be in a position of managing the process. The best people to explain how it works and to get the process going are real estate lawyers in states who use lawyers to close. In states which use escrow companies, the can do the work. The following information is provided:

Steps to Initiate and Conclude a Wrap-Around Mortgage

Initiation:

1. Seller’s Consent: The seller must be willing to offer a wrap-around mortgage. They should have a clear understanding of the risks involved and be comfortable with the terms of the agreement.
2. Property Appraisal: A professional appraisal is typically required to determine the property’s current market value. This will help establish the fair market value of the existing mortgage and the new loan.
3. Negotiation: The seller and buyer should negotiate the terms of the wrap-around mortgage, including the interest rate, loan term, down payment, and any other relevant conditions.
4. Documentation: A written agreement, or wrap-around mortgage deed, should be drafted to outline the terms of the transaction. This document should be reviewed by both parties and their legal counsel.
5. Transfer of Title: The seller transfers title to the property to the buyer, while retaining a lien on the property to secure the existing mortgage and the new loan.

Conclusion:

1. Regular Payments: The buyer makes regular payments to the seller, which cover both the existing mortgage and the new loan.
2. Interest Rate Adjustments: If the interest rate on the existing mortgage changes, the seller may adjust the interest rate on the wrap-around mortgage to reflect the new rate.
3. Prepayment: The buyer may have the option to prepay the wrap-around mortgage, subject to any prepayment penalties outlined in the agreement.
4. Assumption of Existing Mortgage: In some cases, the buyer may assume the existing mortgage, releasing the seller from their obligation to the original lender.
5. Release of Lien: Upon full payment of the wrap-around mortgage, the seller releases their lien on the property,transferring full ownership to the buyer.

Important Considerations:

• Legal Advice: It is highly recommended to consult with a real estate attorney to ensure that the wrap-around mortgage agreement is legally sound and protects the interests of both parties.
• Tax Implications: There may be tax implications for both the seller and buyer, so it’s important to consult with a tax professional.
• Risk Assessment: The seller should carefully assess the risks associated with offering a wrap-around mortgage,including the potential for default and the impact on their financial situation.

By following these steps and carefully considering the factors involved, both the seller and buyer can successfully initiate and conclude a wrap-around mortgage.

Key considerations

Key considerations for a Wrap-around mortgage include the existing contract between the owner and the mortgage company. Most companies have a “due on sale clause”. This means that when the seller sells the property, the mortgage must be paid in full. Most of these transactions are done without the mortgage company being informed. If the mortgage company does find out, they can call the loan in 30 days or longer. Actually, most lenders do not find out about the transfer.

The loan should be for a shorter time e.g. 3-5 years with a balloon payment due. The loan can be structured as a 30 year fully amortized loan due in for example 60 months. The owner may have a 2.5% interest rate and they will charge the buyer 8% retaining the difference as income. It’s better if the buyer pays the seller to keep the insurance policy in place.

If for example the annual policy is $3,000, at closing the buyer will pay the $3,000 to the seller. The seller will have the obligation to keep the insurance in force. Insurance companies often send copies of policies to the lender and you do not want that to happen.

Communication

It’s important for both parties to understand the disposition of the loan and insurance. For this reason, the buyer should send payments for the full amount agreed to the sellers mortgage company. The seller can check on line to see that the payments are being made on time. The seller will send to the buyer a copy of the insurance renewal. There should be no communication between the buyer and the mortgage company. If there is an issue, it must come from the seller.

Title

Usually a quit claim deed is used to make the transfer of the property to the buyer. This gives the buyer all of the rights of an owner. Every state is different, some may use a trust deed. If the buyer fails to make payments, the property can be foreclosed upon based upon the laws of the area where the title was listed. The agreement usually prohibits the buyer from securing a second mortgage or adding any liens to the property until it is paid in full. This protects the sellers interest. Title insurance is usually issued to the buyer as the lender does not require it.

Closing costs are minimal. The seller can decide that the buyer need not create an escrow account for insurance or taxes. On the other hand, the loan amount should reflect a 1/12th cost of insurance and property taxes along with the principal and interest to meet the agreement. Some sellers ask for a few months in advance for taxes and insurance.

The transaction

Wrap-Around Mortgage Transaction-Example

Parties Involved:

• Seller: Mr. Jones
• Buyer: Mr. Smith

Property:

• Selling Price: $300,000
• Down Payment: 10% of $300,000 = $30,000

Mortgage Terms:

• Loan Amount: $300,000 – $30,000 = $270,000
• Interest Rate: 8% APR
• Loan Term: 30 years
• Balloon Payment: 5 years

Monthly Payments:

• Principal and Interest: (Using a mortgage calculator, the monthly payment for a 30-year loan at 8% APR on $270,000 is approximately $1,988.63)
• Property Taxes: $2,000 / 12 = $166.67
• Property Insurance: $3,000 / 12 = $250.00

Total Monthly Payment: $1,988.63 + $166.67 + $250.00 = $2,405.30

Transaction Summary:

Mr. Jones, the seller, is offering Mr. Smith a wrap-around mortgage with a 30-year term and a 5-year balloon payment.Mr. Smith will pay a total of $2,405.30 per month for the first five years. After five years, Mr. Smith will be required to pay off the entire remaining balance of the loan.

Sellers profits

Transaction Analysis for Mr. Jones

Existing Mortgage:

• Principal: $150,000
• Interest Rate: 2.75% APR
• Loan Term: 30 years
• Property Taxes: $2,000 per year
• Property Insurance: $3,000 per year

Wrap-Around Mortgage to Mr. Smith:

• Selling Price: $300,000
• Down Payment: 10% of $300,000 = $30,000
• Loan Amount: $300,000 – $30,000 = $270,000
• Interest Rate: 8% APR
• Loan Term: 30 years
• Balloon Payment: 5 years

Income Analysis:

1. Sale of Property:

• Selling Price: $300,000
• Down Payment: $30,000
• Mortgage Balance (after 5 years): To calculate this, we need to use a mortgage calculator. Assuming a 30-year loan at 2.75% APR on $150,000, the remaining balance after 5 years would be approximately $137,435.
• Net Proceeds: $300,000 – $137,435 = $162,565

2. Interest Income from Wrap-Around Mortgage:

• Interest Differential: 8% – 2.75% = 5.25%
• Average Loan Balance: Assuming an average loan balance of $135,000 over the 5-year period (a conservative estimate), the annual interest income would be $135,000 * 5.25% = $7,087.50.
• Total Interest Income: $7,087.50 * 5 years = $35,437.50

Total Income:

• Sale of Property: $162,565
• Interest Income: $35,437.50
• Total: $198,002.50

As you can see, the deal is very profitable for the seller. Generally the seller will get the full asking price for the property because the seller is financing the property for a buyer with other than stellar credit.

Real Estate Agent Involvement

The real estate agent brings the parties together not unlike a traditional buyer seller arrangement. The seller agrees in advance to pay the real estate agent a commission for bringing the buyer. This is a dual agent transaction. You can decide if you want to ask the seller to pay both ends of the transaction or just one.

Usually the buyer will not have sufficient funds to pay a real estate commission. The seller however will not only sell the property for full asking price or even more, the seller will make money on the interest differential. This type of mortgage can work when everyone is on the same page and the buyer simply has no other choice due to poor credit.

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