Wrap-Around Loan: What It Is, How It Works, Example

What is Wrap-Around Loan?

A wrap-around loan is a form of seller financing where the seller extends credit to the buyer by creating a new mortgage that wraps around the existing mortgage, which remains in place. This arrangement allows the buyer to make payments directly to the seller while the seller continues to pay the original lender.

This structure differs from a traditional loan because the original mortgage is not paid off during the transaction, enabling buyers to purchase property without qualifying for conventional bank financing.

Key Characteristics

Wrap-around loans combine existing mortgage obligations with new financing terms in a single arrangement.

• Seller Financing: The seller acts as the lender, providing credit to the buyer instead of a bank.
• Existing Mortgage Remains: The original mortgage stays active, and the seller continues to make payments on it.
• Interest Rate Spread: Sellers can profit from the difference between the original mortgage rate and the higher wrap loan rate.
• Assumable Mortgages: The seller's existing mortgage often must be assumable to avoid triggering a due-on-sale obligation.
• Junior Lien Position: The wrap loan is subordinate to the original mortgage, increasing risk for both parties.

How It Works

In a wrap-around loan, the seller creates a new mortgage for the buyer that covers the remaining balance on the original mortgage plus any additional amount. The buyer makes monthly payments to the seller based on the wrap loan terms.

The seller then uses a portion of these payments to satisfy their existing mortgage. This setup allows the seller to maintain their original financing while facilitating the sale without the buyer securing a traditional bank loan, which may be difficult due to credit or qualifying issues.

Examples and Use Cases

Wrap-around loans are especially useful in markets with rising interest rates or when buyers have trouble qualifying for conventional financing.

• Real Estate Transactions: Sellers with low-rate mortgages can offer buyers wrap financing at a higher rate, profiting from the interest spread while providing affordable terms.
• Airlines: Companies like Delta leverage flexible financing options to manage capital, analogous to how wrap loans allow creative funding in real estate.
• Credit Management: Buyers who struggle with traditional lending may consult resources like best low interest credit cards to improve credit and eventually qualify for loans without wraparounds.

Important Considerations

Wrap-around loans carry risks, including the possibility that if the buyer defaults, the seller still must cover payments on the original mortgage to avoid foreclosure. Conversely, if the seller fails to pay, the buyer risks losing the property despite making payments.

Understanding the back-end ratio and other debt obligations is essential before entering such agreements. Buyers and sellers should ensure clear terms and possibly structure payments to the original lender directly to mitigate these risks.