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Mia Taylor

How do wraparound mortgages work?

Photo illustration of a hand pulling a $100 bill and wrapping it around a house. (Credit: Photo illustration by Fortune; Original photos by Getty Images (3))

If you’re struggling to obtain a mortgage to purchase a home, there are unconventional options that may be worth exploring, including the not very well-known wraparound mortgage.

This unique arrangement involves a home seller providing financing to a prospective buyer rather than a bank or mortgage lender. The buyer, in turn, makes payments on the home to the seller. 

If it all sounds slightly unusual, that’s because it is. And there are some risks and drawbacks associated with this type of financing.

What is a wraparound mortgage? 

A wraparound mortgage is a complex arrangement through which a home seller retains the mortgage on their property and takes on the role of the lender by offering the prospective buyer financing to purchase the home.

The name wraparound comes from the fact that the financing the seller offers the buyer "wraps" around the existing mortgage. This secondary financing provided to the buyer is made in an amount that will cover both the cost of the outstanding principal still due on the seller’s mortgage and the additional cost associated with the home’s sale price.

This approach of using seller-provided financing rather than bank financing can be easier for a buyer who may have encountered challenges qualifying for a traditional mortgage.

“A wraparound mortgage is a creative way to make a home loan work where it traditionally wouldn’t otherwise,” explains Brian McCauley, a mortgage lender with Fairway Independent Mortgage Corporation, The McCauley Team. “This creative financing allows buyers to obtain a loan and purchase the home without getting an everyday mortgage.”

How do wraparound mortgages work? 

The key element of a wraparound mortgage is the seller providing the financing to a buyer in an amount that’s enough to cover both the balance on the existing mortgage and the additional cost of the home’s sale price. But that’s not the only feature of how these financing arrangements work.

The interest rate on wraparound financing will typically be higher than the interest rate on the original home mortgage held by the seller. This allows the seller to make a profit as a result of the financing agreement. Each month the buyer makes payments to the seller, and the seller, in turn, pays the monthly mortgage. The seller is able to pocket the difference between the original mortgage payment amount and the payment amount the buyer is making at the increased interest rate.

“In a transitioning market such as the one we have now, we see this as a creative option for buyers to buy the home they want and sellers to not only sell their home at top dollar but potentially make some extra interest income,” says Josh Massieh, CEO and mortgage broker at the mortgage company Pacwest Funding. 

Also, as part of this arrangement, the buyer and seller agree on a down payment amount and sign an agreement laying out all of the financing terms. In some cases, the buyer will immediately be put on the home’s title and the deed transferred to the buyer. However, some financing arrangements may stipulate that the title is not transferred until the loan is fully paid.

Wraparound mortgage example

Here’s an example of how a wraparound mortgage would work in practice.

Stacy is selling her home for $250,000 and has an existing mortgage balance of $100,000 at an interest rate of 3.5%. The new buyer, Steve, cannot qualify for a traditional loan, so Stacy decides to finance the buyer and become the bank. 

Stacy and Steve agree to a loan amount of $240,000 with an interest rate of 6.75% and a down payment of $15,000.

The deal closes, and Steve pays Stacy the monthly payment while Stacy pays her current mortgage that’s still in place and pockets the rest since anything other than the minimum payment on her current home loan is profit.

Wraparound mortgage benefits 

For prospective buyers who are unable to qualify for a conventional mortgage, a wraparound mortgage can be a much-needed way to make homeownership affordable.

“Benefits to a buyer can include a blended rate below market or getting into a home that they may not qualify for if trying to use a traditional mortgage structure,” says Mason Whitehead, of the national lender Churchill Mortgage. “And it may even be a lower cost structure for the buyer from a fee standpoint.”

There are also benefits for sellers in this financing arrangement, which include making a profit by acting as the lender. Offering wraparound financing can also possibly make a home more attractive to prospective buyers in a tough market.

Wraparound mortgage drawbacks 

Though wraparound mortgages offer a valuable homebuying option, these financing agreements also come with risks for both parties involved. For instance, the home seller may stop making payments on the original loan and just pocket all of the payments.

“If the seller doesn't pay the existing mortgage, the original lender can still foreclose on the house,” says Massieh.

This means that even in cases where the buyer upholds their end of the arrangement, making payments on time, the deal could backfire. Conversely, the home buyer could stop making the payments agreed to as part of the financing arrangement.

“If the buyer doesn’t pay, the seller has to go through the foreclosure process—if the buyer was put on the title. Or the eviction process, if the buyer wasn’t put on the title,” says Whitehead. “This can be costly and time-consuming, depending on your state’s requirements.”

The takeaway 

Wraparound mortgage financing offers an alternative way for some prospective buyers to access home ownership. This type of financing can actually be a win-win, as it also allows home sellers to make additional profit as a lender and may make a home more attractive to a wider group of buyers. But before proceeding with wraparound financing, be sure you fully understand how this arrangement works and are comfortable with the risks.

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