A wraparound mortgage is a form of seller financing where the seller becomes the lender by offering the buyer a loan that includes the balance of the seller’s existing mortgage plus any additional amount to cover the purchase price. The buyer makes monthly payments to the seller based on this new loan, and the seller uses part of these payments to keep current on the original mortgage. This setup is often used when buyers face challenges obtaining traditional financing or when sellers want to attract buyers with more flexible terms.

How It Works:

  • The seller retains their original mortgage on the property.
  • The buyer agrees to purchase the property and takes on a wraparound mortgage loan from the seller.
  • The buyer’s loan amount “wraps around” the seller’s mortgage balance.
  • The buyer pays the seller, who then pays the original lender.

Benefits for Buyers:

  • Typically easier qualification compared to traditional bank loans.
  • Lower closing costs due to reduced lender fees.
  • Potentially better interest rates if the seller’s existing mortgage rate is favorable.
  • Faster closing process.

Benefits for Sellers:

  • Attracts more buyers, especially in tight credit markets.
  • Earn interest income on the loan difference.
  • Possibility to defer capital gains tax by structuring as an installment sale.
  • Maintains a financial interest in the property.

Risks:

  • The “due-on-sale” clause in most mortgages allows the original lender to demand full repayment if the property ownership changes, which can pose risks to both parties.
  • If the seller fails to pay the original mortgage, the lender can foreclose, putting the buyer’s ownership at risk.
  • Sellers bear the risk of buyer default, creating potential financial strain.

Because of these complexities, both buyers and sellers should work with experienced real estate attorneys to draft comprehensive agreements and understand local laws. Using a third-party loan servicing company can help mitigate risks by managing payments and documentation professionally.

For more on seller financing methods, see Seller Financing and details on loan transfer risks in Loan Assumption.

For authoritative guidance, consult IRS guidelines and consider working with financial advisors to assess tax implications. According to IRS Tax Topic 701, installment sales have specific reporting requirements that might apply when using wraparound mortgages.

References:

This approach remains a useful alternative financing option in certain real estate transactions, particularly when traditional financing is limited or less advantageous.