What Is A Wraparound Mortgage And Is It Right For You?
Trying to sell your home but struggling to find buyers who can qualify for a traditional mortgage loan? Or maybe you're a buyer who can qualify for a mortgage – but only at high interest rates. If so, a wraparound mortgage might be a good option.
Let’s take a closer look at what a wraparound mortgage is, the risks of using this type of home financing and who ultimately benefits from using a wraparound mortgage.
What Is A Wraparound Mortgage?
A wraparound mortgage is an uncommon type of mortgage. The seller of the home keeps their mortgage active while the buyermakes payments to the seller. In this case, the seller – not a bank or lender – offers the mortgage and transfers the home’s title directly to the buyer. This is known as seller financing because the buyer pays the seller directly.
While a wraparound loan isn’t common, there are situations when a wraparound loan works for both the buyer and the seller. The seller can pay off their existing mortgage and profit from charging the buyer a higher interest rate than their existing mortgage rate. And if the buyer struggled to qualify for traditional financing, a wraparound mortgage can help make homeownership accessible.
A wraparound mortgage can be mutually beneficial – but there are several risks as well.
Wraparound Mortgage Example
Here's how a wraparound mortgage works in a real estate transaction: Say you want to sell your home for $225,000. And whenyou put your home on the market, you still owe $50,000 on your mortgage.
You find buyers who agree to your asking price of $225,000, but the buyers can't qualify for a loan from a traditional mortgage lender. A wraparound mortgage might help you close the deal.
First, contact your mortgage lender to confirm that you can participate in a wraparound agreement. Many lenders require the homeowner to make a lump-sum payment on the remaining mortgage balance when they sell their home. But if your loan is assumable – meaning a buyer can take over your mortgage – your lender might allow a wraparound arrangement.
Let’s say the buyers make a $10,000 down payment and borrow the remaining $215,000 in a wraparound mortgage from you, the seller. When the buyers make their monthly payments to you, you will make your monthly payments to your mortgage lender until you pay off the $50,000 you still owe. You collect the remaining $165,000 over the remainder of the term.
Who Benefits From A Wraparound Mortgage?
Wraparound mortgages are typically more beneficial to sellers. That’s largely because sellers can charge a higher interest rate than the rate on their existing mortgage loan. Because of the hike in interest, sellers stand to make a solid profit.
But wraparound mortgages can also benefit buyers.
Home buyers with damaged credit or a short credit history may not qualify for a traditional mortgage. A wraparound mortgage may be the key that unlocks the door to homeownership for these buyers.
But wraparound mortgages are rare for a reason. They can be complicated to arrange, and most buyers and sellers typically find it easier to work with lenders and conventional or government-insured mortgage loans. But, under certain circumstances, a wraparound mortgage may help sellers sell their home and help buyers purchase a home.
Risks Of Wraparound Mortgage Loans
While a wraparound mortgage loan can help owners sell a home when they’re struggling to attract buyers, the loan has its risks.
The seller in a wraparound mortgage arrangement takes on all the dangers of a traditional mortgage lender. If your buyer stopsmaking their monthly payments, you can’t rely on their payments to pay back the rest of your existing mortgage loan. If you can’t make your payments, you might default on your mortgage. If you default on your mortgage, your lender could take ownership of your home through the foreclosure process.
But there’s a risk for buyers, too. Say you purchase a home with a wraparound mortgage and make on-time payments every month. If the seller doesn’t make their monthly payments to their lender, the lender can foreclose on the home while you're living in it. It won’t be your fault that the seller didn’t make their mortgage payments – but you’ll still lose your home.
Many mortgage loans have a due-on-sale clause. The clause requires the seller to pay off whatever they owe on their mortgage loan when their home is sold. You can’t offer a wraparound mortgage if your loan has a due-on-sale clause. If you ignore the clause, sell your home and your lender finds out, they may choose to enforce the clause and demand immediate payment of your mortgage balance. If you can’t pay it, you’ll risk losing your home.
How To Arrange A Wraparound Mortgage
The key to making a wraparound mortgage work is to get approval from your mortgage lender. If your mortgage loan includes a due-on-sale clause, you likely won’t be able to close a wraparound mortgage. You should reach out to your lender before making any arrangements with a buyer to avoid the risk of losing your home.
Wraparound Loan Alternatives For Buyers
When a wraparound loan isn’t an option, there are steps you can take to qualify for other types of loans, like rebuilding your credit score. And you can talk to a lender to explore loan alternatives, including:
- FHA loans: FHA loans are mortgages insured by the Federal Housing Administration. The loans offer a 3.5% down payment if your FICO® credit score is at least 580. Although Rocket Mortgage® requires a 580 credit score, select lenders may qualify you with a score as low as 500 if you make a 10% down payment. You should know that a higher interest rate is likely.
- VA loans: VA loans are insured by the Department of Veterans Affairs. Like USDA loans, VA loans typically don’t require a down payment, but they’re only available to qualified active-duty service members of the U.S. armed forces, reservists, National Guard personnel, veterans and surviving
- USDA loans: TheS. Department of Agriculture guarantees USDA loans. The loans are attractive because they require no down payment. You must buy a home in an area the USDA designates as rural. Rocket Mortgage does not offer USDA loans at this time.
- Conventional mortgages: Conventional mortgage loans aren’t insured by a U.S. government agency. Today, manyconventional mortgages allow borrowers to buy homes with a 3% down payment if you are a first-time home buyer or meet income limits. A credit score of 620 or better is required.
The Bottom Line
Wraparound mortgages remain rare options in today’s housing market. There are simply too many other loan types that work for buyers with credit challenges or limited funds for down payments.
While a wraparound loan can help sellers if they’re struggling to find buyers, it’s usually easier for all parties when a buyer bringsa government-insured or conventional mortgage to the closing table.
Want to learn about your mortgage options? Head to Rocket Mortgage and start the approval process to find the best home loan for you. You can also give us a call at (888) 452-0335.