A wraparound mortgage is seller financing written on top of a loan the seller already has. The buyer pays the seller on a new, larger note, and the seller goes on paying the original lender and keeps the difference.
How the money moves
Suppose you own a house with a bank loan still on it. You sell the house and carry the financing yourself without paying off the bank. Your buyer signs a new note to you for the amount they are financing, and that note “wraps around” the old loan, which stays in place and is called the underlying loan.
From then on, the buyer pays you each month and you pay your lender out of what you receive. As an example, if the buyer pays you $1,500 a month and your own loan payment is $900, you keep $600. The wraparound note is written for a larger balance than the underlying loan, and sometimes at a higher rate, which is where that monthly difference comes from.
Who owes what to whom
| Underlying loan | Wraparound note | |
|---|---|---|
| Who is owed | The original lender | You, the seller |
| Who is responsible for paying | You | The buyer of the property |
| Lien position | Ahead of the wraparound | Behind the underlying loan |
| Who is in the deal | You and the lender | You and the buyer |
Lien position is the order in which claims against a property are paid if it is sold or foreclosed. The underlying loan was recorded earlier, so it is paid before your wraparound. Anyone valuing a wrap therefore needs the balance and payment on both loans, and we ask for both when you send us a wraparound note to price.
Why a seller would set one up
A wrap suits a sale where the buyer cannot get a bank loan and the seller cannot, or would rather not, pay off the existing one. That is most tempting when the existing loan carries a low rate the seller wants to keep. It also suits a seller who prefers monthly income to a single check.
Where it can go wrong
The buyer of the property depends on you. If they pay you and you fail to pay the lender, the lender can foreclose on a house the buyer has been paying for faithfully. For that reason a careful buyer asks for a servicing company to collect the payment and send the lender’s share directly.
You carry the opposite risk. The underlying loan stays in your name, so if the buyer stops paying, your lender still expects its payment on time and it comes out of your pocket.
Then there is the due-on-sale clause, a term in bank loan documents that lets the lender demand the whole balance if the property is transferred without the loan being paid off. A wraparound involves that kind of transfer. Whether your loan contains the clause, and what the lender may do about it, is a question for an attorney who has read your loan documents. The risk stays for as long as the underlying loan does.
How it differs from a second mortgage
Among the types of note a buyer sees, the nearest relative of a wrap is a second mortgage. With a second mortgage, the borrower pays two lenders directly. With a wrap, the borrower pays one person, the seller, who passes part of the money on. Both sit behind an earlier lien and note buyers treat both with caution, but the wrap adds the question of whether the pass-through payment is reliably made.
Selling a wraparound note
A wraparound note can sometimes be sold. Fewer buyers bid than on a first-lien note, and the price of a wraparound mortgage note reflects the loan sitting ahead of it and the due-on-sale risk. A buyer may make it a condition that the underlying loan is paid off at closing out of the sale proceeds.
If you already hold a wrap, the document to find is the latest statement on the underlying loan, because its balance and payment decide what a buyer can offer. Keep it with your wraparound note and security document. The law on wraparounds varies by state, so if you are creating one or selling one, have an attorney in the property’s state review it first.
Related questions
Is a wraparound mortgage legal?
The rules on wraparounds differ from state to state. The existing loan's due-on-sale clause is a separate contract issue with the lender. Have an attorney in the property's state review any wrap before you sign.
Who pays the property taxes and insurance on a wrap?
The wraparound documents should say. It may be the buyer of the property, sometimes through a servicing company that also forwards the underlying loan payment. If the documents are silent, that is a gap worth fixing.
What happens when the underlying loan is paid off?
The seller's wraparound becomes the first lien on the property, assuming nothing else was recorded ahead of it, and the full payment from the buyer is then the seller's to keep. A note in that position is much easier to sell.