As I write this, interest rates are at a 20-year high, and real estate values have significantly increased. In this climate, you, as a real estate investor, must get creative with financing.

One potential creative option is the wraparound mortgage, a version of subject-to-mortgages.  It’s a form of seller financing where the seller maintains their existing mortgage, you come in with some additional cash and, offer a higher interest rate, then assume control of the property.

The seller benefits from both the cash you provide and the interest rate spread. Meanwhile, you acquire a property with minimal cash out of pocket.

Interested to learn more? Continue reading to see if wraparound mortgages could be a viable option for your real estate investing business.

TL;DR

  • Wraparound mortgage: Creative financing for real estate investors.
  • Buyer gets secondary mortgage from seller, maintaining original mortgage.
  • Monthly payments cover both mortgages, potential profit for seller.

What Is A Wraparound Mortgage?

A wraparound mortgage is a loan where the seller extends a secondary mortgage to the buyer that includes and adds to any existing mortgage on the property.  

It’s a form of secondary financing that allows the buyer to make one monthly payment to the seller, who then uses part to pay off their original loan with the possibility of earning a profit from the difference in interest rates.

Here’s how it can work:

Say you want to buy a house priced at $300,000. The seller still owes $200,000 on their original mortgage with an interest rate of 3%.  Instead of paying the full price upfront or securing a traditional mortgage for the full amount, you and the seller agree on a wraparound mortgage.

How Wrap-Around Mortgages work?

In this arrangement, the seller offers you a mortgage for the full purchase price of $300,000, but at a higher interest rate of 5% (which is GREAT in today’s market).  You agree to make monthly payments based on this amount and interest rate directly to the seller.

Here’s the breakdown:

– Original Mortgage: $200,000 at 3% interest.

– Wrap-Around Mortgage: $300,000 at 5% interest.

Each month, you pay the seller based on the $300,000 at 5%. The seller uses a portion of this payment to continue paying off the original mortgage of $200,000 at 3% and keeps the difference as profit. If the original mortgage requires a payment of $1,000 per month, but your payment to the seller is $1,800 per month, the seller earns $800 per month in profit after paying the original mortgage.

This arrangement allows you to purchase the home with a potentially easier qualification process while the seller gains the benefit of earning interest on a larger principal at a higher rate.

How does a wraparound mortgage work?

As a real estate investor considering a wraparound mortgage, here are the steps you would typically follow:

Step 1: Identify a Property: Find a property where the seller is willing to use a wraparound mortgage and the seller has an existing mortgage with a low-interest rate.

Step 2. Negotiate:  Negotiate the terms of the wraparound mortgage with the seller. You will need to agree on the total amount of the new mortgage (which includes the seller’s mortgage), the interest rate, and the payment schedule.

Step 3. Review the Existing Mortgage: Study the seller’s existing mortgage terms. You need to know the remaining balance, interest rate, and whether there’s a due-on-sale clause that could complicate or prohibit a wraparound mortgage.

Step 4. Legal Review: Consult with a real estate attorney or personal finance advisor. They can help you understand the legalities, risks, and financial implications of entering into a wraparound mortgage agreement.

Step 5. Finalize the Agreement: Once terms are agreed upon, finalize the wraparound mortgage agreement. This should be a legally binding document detailing all terms of the agreement, including the responsibilities of both parties.

Step 6. Make Payments:  Following the agreement,  the buyer pays monthly payments to the seller based on the agreed terms. These payments are typically higher than the seller’s existing mortgage payment, allowing the seller to pay off their mortgage and keep the difference.

7. Monitor the Mortgage: Regularly monitor the status of the seller’s original mortgage to confirm it’s being paid off as agreed. You don’t want the seller to default and risk the property being foreclosed.

8. Manage the Property: As with any investment property, whether you plan on renting it out or reselling, proper management helps you maximize your investment.

9. Closure of the Deal: When you fully pay the wraparound mortgage, verify that the property title is properly transferred to you, free and clear of any liens or encumbrances.

Pros and Cons of Wraparound Mortgage

Just like all creative financing strategies, there are pros and cons to a wraparound mortgage, including:

Pros and Cons…
  • Flexible Terms: You’ll find more room to negotiate loan terms. This could mean securing lower interest rates, longer repayment periods, or other conditions that better fit your financial needs.
  • Easier Qualification: These mortgages often have less stringent qualification criteria compared to traditional loans. This can be a big plus if you have a lower credit score or irregular income, making it easier for you to finance an investment property purchase.
  • Lower Closing Costs: You can save on closing costs with a wraparound mortgage. Since you’re taking over an existing mortgage, you bypass the need for a new loan origination, which can lead to substantial savings.
  • No Bank Approval Needed: Unlike traditional mortgages, wrap-around mortgages don’t require bank approval. This is beneficial if you’ve had trouble securing a mortgage through conventional means, allowing for a quicker purchasing process.
  • Investment Opportunity: For real estate investors, wraparound mortgages offer a chance to buy a property with an existing mortgage, take over the payments, and possibly earn rental income. This can be an effective way to grow your real estate portfolio.
  • Higher Risk: You’re taking on a higher risk with a wraparound mortgage. By assuming an existing mortgage and adding a new loan, you risk losing the property if the original mortgage defaults.
  • Primary Loan Challenges: The existing loan may not be an assumable mortgage and could present a challenge to this form of seller financing.
  • Dependence on Seller’s Reliability: Your financial stability depends on the seller’s ability to make timely payments on their mortgage. If they pocket or miss payments, it could jeopardize your ability to make payments and might lead to foreclosure.
  • Complexity and Legalities: Wraparound mortgages are more complex and come with legal intricacies. Be sure to consult with a financial advisor or real estate attorney to verify you fully understand the terms and the legal implications of the loan.

Tips For Wraparound Mortgages

So you’ve found a seller willing to do a wraparound mortgage – great!!  Here’s some tips for success:

Property Analysis

Run an investment analysis just like you would for any other real estate investment purchase.  Look at the property itself – its condition, market value, and potential for future growth. Make sure that you’re making a good decision and getting a fair deal.  

Here’s an example of a cash flow analysis for a property using a wrap-around mortgage:

  • Property Price: $250,000
  • Market Comparison: Similar homes are selling for $260,000.
  • Repairs: Estimated at $10,000.
  • Total Investment: $260,000 (purchase + repairs).
  • Mortgage Terms: Seller offers a wrap-around mortgage at 5% interest on the entire $250,000, with an existing mortgage of $200,000 at 4% interest. You negotiate a zero down payment.
  • Rental Income: You plan to rent the property for $1,500 monthly.
  • Monthly Cash Flow: After mortgage payments, taxes, insurance, and maintenance, your net is $200 per month, or $2,400 annually.
  • Cash on Cash Return: With $10,000 out-of-pocket for repairs, your return is $2,400 / $10,000 = 24%.

This analysis shows a potentially profitable investment, with a 24% cash-on-cash return, thanks to the favorable mortgage terms and rental income. 💥

Work with Professionals

Seek guidance from professionals experienced in wraparound mortgages, such as real estate attorneys or mortgage brokers. They can help you understand the legal aspects, negotiate favorable terms, and protect your interests.

Review Financials Carefully

Examine the seller’s financial records, including their payment history on the underlying mortgage. You need to verify that the seller has been making timely payments to avoid any surprises in the future.

Seller Communication

Establish open and honest communication with the seller throughout the transaction. Clarify expectations, discuss monthly mortgage payment arrangements, and confirm that both parties understand the terms and responsibilities.

Proper Documentation

Document everything related to the wrap-around mortgage, including the sales agreement, promissory note, and other relevant paperwork. It protects both you and the seller and helps avoid any misunderstandings or disputes in the future.

Consider Refinancing

In the future, you should consider exploring refinancing with a conventional loan. Keep an eye on several factors before making this decision: any fluctuations in interest rates, changes in your financial circumstances, or any developments regarding the property’s condition or value.

Alternatives to a Wrap-Around Mortgage

While a wrap-around mortgage can be a viable financing option, what other creative financing options can you use?

  • Conventional Mortgages: Of course, you could get a traditional mortgage. It likely requires more stringent eligibility criteria but offers stability and a straightforward payment structure.
  • Seller Financing: Sellers may be willing to provide direct financing to you. I’ve used seller financing multiple times in my real estate investing career.  
  • Rent-to-Own Agreement: Another alternative is a rent-to-own agreement. This arrangement lets you rent the property for a specified period with the option to buy it at the end of the lease term.
  • Bridge Loan: A bridge loan is a short-term loan that provides temporary financing until a more permanent solution, such as selling an existing property, is finalized. It can be useful if you need immediate funds to buy a property but expect to have the means to pay off the loan in the near future.  An example would be if you are flipping a property.
  • Home Equity Loan or Second Mortgage: If you already own a property, you can explore using a line of credit (HELOC) or a second mortgage to finance the purchase of another property. You can borrow against the equity in your current home, providing funds for the down payment or purchase.
  • Government Programs: Various government programs, such as Federal Housing Administration (FHA) loans or Department of Veterans Affairs (VA) loans or United States Department of Agriculture (USDA) loans, offer alternative financing options with flexible eligibility requirements and potentially lower down payments.  However, many of these programs have requirements where you must live in the property as your primary residence.  
US Deparment of Housing and Urban Development

Conclusion

The wraparound mortgage presents a potentially advantageous financing option for both investors and sellers.

It offers a path for you to purchase properties, even in a market with soaring real estate values and high-interest rates, with minimal initial cash outlay. For sellers, it provides a way to sell their property quickly while benefiting from the interest rate spread. Both the buyer and seller win in this strategy.

Be sure to understand the terms and assess the risks involved in a wraparound mortgage agreement. Always seek the counsel of professionals like real estate attorneys to review terms and risks.

Wraparound Mortgage FAQs

Are wraparound mortgages legal?

Wraparound mortgages are legal, but they can involve legal complexities. Working with real estate attorneys is recommended to make sure that all terms and conditions are properly addressed and documented.

How do I find properties that offer wraparound mortgages?

The strategy is the same as finding subject-to-properties.  I find some of the best approaches are to develop a network of other local real estate investors and wholesalers who can refer opportunities to you.    

Can I refinance a property with a wraparound mortgage?

Refinancing a property with a wraparound loan can be tricky since it involves the seller’s existing mortgage with the original lender. It’s best to consult with lenders or financial advisors to explore refinancing options.