Understanding Wraparound Mortgages: A Comprehensive Guide
A wraparound mortgage is a unique financial strategy that combines an existing mortgage with a new one, effectively wrapping them into a single loan. This approach allows for more flexibility and can be beneficial in various real estate transactions. Below, we delve into the mechanics, benefits, and practical examples of wraparound mortgages to give you a clear understanding of this financial tool.
How a Wraparound Mortgage Works
Rather than taking out two separate loans—a first and a second mortgage—a wraparound mortgage incorporates both into one. Here’s how it works:
- Existing Mortgage: Assume an existing first mortgage stands at $100,000 with a 4% interest rate.
- Additional Financing: Instead of arranging a second mortgage for $50,000 at 8% interest, the borrower opts for a wraparound mortgage of $150,000 at 6% interest.
- Financial Flow: The first mortgage of $100,000 remains unchanged. The borrower makes a single payment on the $150,000 wraparound mortgage to the wraparound lender.
- Payment Handling: The wraparound lender, in turn, makes the required payments on the original $100,000 mortgage.
Practical Example
Let’s break down the figures to illustrate this better:
- Original mortgage: $100,000 at 4% = monthly payment of approximately $528
- Wraparound mortgage: $150,000 at 6% = monthly payment of approximately $966
Financial Breakdown:
- Seller receives $50,000 cash from the buyer and an additional $50,000 from the wraparound lender.
- Wraparound Lender handles the existing $100,000 mortgage payments and collects payments from the buyer on the full $150,000 wraparound mortgage.
- Buyer makes payments totalling $966 per month.
- Lender pays $528 towards the original mortgage, keeping the difference of $438 monthly, which results in a yield approximately of 9.53% over 25 years.
FAQ Section
What are the advantages of a wraparound mortgage?
Wraparound mortgages often provide lower closing costs and additional flexibility for both buyers and sellers. They can also allow buyers with less-than-perfect credit to secure financing.
Are there any risks involved?
Yes, if the wraparound lender fails to make payments on the original mortgage, the property might face foreclosure. It requires careful vetting and trust between all parties involved.
Can it affect the sale price of the property?
Potentially, yes. Down payments and interest rates involved in wraparound mortgages can influence the property’s final sale price, often providing a favorable deal for both buyers and sellers.
Is a wraparound mortgage the same as a second mortgage?
No, they differ. A second mortgage is quite separate from the first, while a wraparound mortgage compounds both loans into one, forming a singular payment obligation with distinct advantages.
Related Terms: subordinate mortgage, second mortgage, mortgage refinancing, real estate investing.
