What is a Wrap-Around Loan
A wrap-around loan is a type of mortgage loan that can be used in owner financing deals. This type of loan involves the seller’s mortgage loan on the home and adds an additional incremental value to arrive at the total purchasing price that must be paid to the seller over time.
BREAKING DOWN Wrap-Around Loan
Wrap-around loans are a common form of financing used in seller financed deals. They take on the same characteristics as a seller financed loan but they factor a seller’s current mortgage into the financing terms.
Seller financing is a type of financing that allows the buyer to pay a principal amount directly to the seller. Seller financing deals have high-risks for the seller and usually require higher than average down payments. In a seller financing deal, the agreement is based around a promissory note which details the terms of the financing. In seller financing deals, principal is not required to be exchanged upfront and the buyer makes installment payments directly to the seller which include notional principal and interest.
Wrap-Around Loan Structuring
Wrap-around loans build on the owner financing concept and deploy the same basic structuring. A wrap-around loan structure is used in an owner financing deal when a seller has a remaining balance to pay on the property’s first mortgage loan. A wrap-around loan takes into account the remaining balance on the seller’s existing mortgage at its contracted mortgage rate and an incremental balance added to arrive at the total purchase price. In a wrap-around loan the seller’s base rate of interest is based on the terms of their existing mortgage loan. To break even, the seller must at least earn interest that matches the rate on the loan for which they still have to repay. Thus, a seller has the flexibility to negotiate the buyer’s interest rate based on their current terms. Generally, the seller will want to negotiate the highest possible interest rate in order to make payments on the first mortgage and also earn a spread on the deal.
Wrap-around loans can be risky for the seller since they take on the full default risk on the loan. Sellers must also be sure that their existing mortgage does not include an alienation clause which requires them to repay the mortgage lending institution in full if collateral ownership is transferred or if the collateral is sold. Alienation clauses are common in most mortgage loans which often prevent wrap-around loan deals from occurring.