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Wraparound mortgages allow people without good credit to buy homes, but they come with a risk for both sellers and buyers.
With a wraparound mortgage, the seller of a house takes on the responsibility of lending money to a buyer. So when you sell your house, instead of the buyer taking out a new mortgage from a traditional lender, such as a bank, you take out a mortgage covering both your new home and your old home, and then you sign a mortgage agreement transfer to the buyer.
The buyer sends mortgage payments directly to you. Your new mortgage, is considered to “wrap around” because it goes beyond your new property to also cover your old property.
Wraparound mortgages are useful during slow housing markets and when a buyer doesn’t have the necessary credit to secure a traditional mortgage. And while a seller can turn a nice profit, this kind of loan does pose some risks to both the seller and the buyer.
Normally, if you are selling a house, the buyer will take out a mortgage and use it to pay for the house. Then you can move on to focus on paying for your new house.
In the case of a wraparound mortgage, you take out a second mortgage that covers the cost of both your new home and the remaining mortgage on your old home. Then, when you sell your old house, the buyer, instead of going to a lender to get a mortgage, will just make monthly mortgage payments directly to you.
With a wraparound mortgage, you will be paying for the mortgage on your new home, and you will be paying the remaining mortgage on your old home by using the payments that the buyer sends you. The result is that the buyer is getting a mortgage from you instead of a traditional lender.
The name of this type of loan comes from the fact that your new mortgage “wraps around” the cost of both mortgages. You may also see the terms wrap mortgage, wraparound loan, or seller carry-back financing.
Your new mortgage is also considered a second mortgage, or a junior mortgage.
You can only create a wraparound mortgage with an assumable loan. Assumable loans are a type of loan that allows a seller to transfer their mortgage to a buyer with little or no changes to the original mortgage agreement. In particular, you can transfer a mortgage without changing the interest rate.
Many conventional mortgages are not assumable loans. To help you understand your specific loan agreement, the safest thing is to talk with a real estate attorney.
Trying to make off a profit by selling a house is a common practice, but getting a wraparound mortgage can maximize how much you make. Market conditions will also play a part. Here are a couple of reasons when you may want to consider getting this type of loan.
The mortgage you transfer to a buyer will have a higher interest rate than your new mortgage. That can make wraparound mortgages a profitable move for sellers.
For example, let’s say you get a new mortgage with an interest rate of 5%. The mortgage you give your buyer has a rate of 7%. You can pocket the 2% difference.
However much the buyer pays over your remaining mortgage is also profit for you. So let’s say you had a $100,000 mortgage remaining on your old house. The buyer is paying a $250,000 mortgage to buy the house from you. The difference between your remaining mortgage and the buyer’s mortgage ($150,000 in this case) is profit for you.
Because of the potential to make money, wraparound loans are one option for people who want to invest in real estate.
If someone doesn’t have strong enough credit to secure a mortgage from a traditional lender, a wraparound mortgage could be a good alternative.
This is especially true in a slow housing market because lenders typically become more strict about who they will lend to. If you’re trying to sell in a slow market, you could lose potential buyers just because other lenders are being more cautious.
One of the biggest risks with a getting wraparound mortgage is that the lender of the original mortgage (for the house being sold) will trigger a due-on-sale clause.
Conventional mortgages typically have a due-on-sale clause that allows the lender to ask for the remaining mortgage when a homeowner sells their house. If you have a $100,000 balance remaining on your mortgage, and you try to secure a wraparound loan, your original mortgage lender can ask for the $100,000 as soon as you sell the house. If you cannot make that full payment, the lender will foreclose on (take possession of) the house.
Because you are acting as a mortgage lender, you assume the typical risks of a lender. If the buyer doesn’t make their payments, you will have to find a way to get the money. This could leave you unable to pay for your old house, the new house, or both. If you can’t get the payments, you could have to foreclose.
The buyer is taking on risk because they have to trust that the seller will actually make the payments on the new mortgage.
If you get a wraparound mortgage, the payments you make go toward paying the original house’s mortgage first. So if you don’t make your payments, the old property will go into foreclosure before the new one. That could leave the buyer without a home, even if they’ve been making their payments.
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Derek is a tax expert at Policygenius in New York City. He has written about multiple personal finance topics in the past, and his work has been covered by Yahoo Finance, MSN, Business Insider and CNBC.
Policygenius’ editorial content is not written by an insurance agent. It’s intended for informational purposes and should not be considered legal or financial advice. Consult a professional to learn what financial products are right for you.
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