Wraparound Mortgages
Wraparound mortgages are second mortgages that include an existing first mortgage. Thus, the total amount covered by the mortgage is the outstanding balance of the first mortgage plus the additional amount the borrower needs to borrow. Note that since this is a second mortgage it is subordinated to the existing loan, and thus it is more risky. In this sense it calls for a higher rate compared to the existing loan. The existing mortgage is referred to as the consolidated loan. The way it works is that the wraparound lender receives the loan payment on the total amount based on the interest rate and amortization schedule stipulated in the loan contract and uses a portion of that amount to make payments on the existing mortgage. The wraparound mortgage represents a tool often used by real estate investors for the acquisition of properties that are burdened with an existing loan. Quite often the wraparound lender is the seller himself/herself. Sellers might be motivated to become the wraparound lenders in order to facilitate the transaction, while earning an attractive annual return, as it will be shown below. Search Our Over 150-Page Website!
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To better understand how this type of mortgage is used consider an investor considering to purchase a property valued by the bank at $500,000 with an existing outstanding loan balance of $ 269,176.29 at a 6% interest rate (remaining balance of a $300,000 loan made 5 years ago and amortized over a 25 year term). Under these circumstances the investor decides to put $100,000 from his own pocket and arrange a mortgage of $400,000 at 8% for 20 years that will include and the existing loan. Under these terms the following cash flows will occur:
Wraparound loan : 400,000.00 Uses of the Wraparound Mortgage
According to J. Cummings (Real Estate Financing Manual) the most common uses of the wraparound mortgage include: 2. In cases that the existing loan has provisions that may make pre-payment difficult or expensive, which is more likely to be the case when the property is burdened with several loans 3. In cases that the existing loan has a non-assumption clause, since when a wraparound mortgage is given to a seller, the former remains responsible for making the required debt service payments for the first loan 4. In times when the mortgage market is tight and it is difficult to get mortgage loans 5. When re-financing costs become a major problem
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