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Deconstructing wrap-around loans: How do they work?

The word sounds pretty simple: "wrap-around." But that doesn't mean everyone understands what they're getting into when they say "yes" to a wrap-around mortgage. These loans are not uncommon and they can work well for a seller-financed loan when the seller still owes money on the mortgage.

To understand a wrap-around mortgage, first we need to understand seller financing:

What is seller financing?

Seller financing in real estate transactions involves the buyer paying a principal amount of the purchase price to the seller. However, it's important to note that this principal amount will not usually be paid up front. Rather, it will be paid in installments.

The sale agreement related to a seller-financed mortgage will include a promissory note that describes the payments that the buyer will make to the seller in detail.

Seller financing can be risky for the seller since he or she will not receive the full amount of the purchase price immediately upon letting go of the property. There's no guarantee, after all, that the buyer of the property will complete all the payments on the promissory note.

What is a wrap-around mortgage?

A wrap-around mortgage incorporates the seller's existing mortgage balance within the financing terms. Essentially, the seller will still need to make payments on his or her mortgage balance. The seller will ensure that the payments made on the promissory note in a seller-financed deal meet (and usually exceed) the amount that needs to be paid on the mortgage loan.

Like seller financing, wrap-around mortgages are risky for the seller. However, in comparison to seller financing, the risk associated with wrap-arounds is even higher. This is because the seller retains full default responsibility for the mortgage. If the buyer stops paying, the seller will still be responsible for the remaining balance.

Learn more about wrap-around loans before entering into a wrap-around mortgage purchase agreement

Selling or buying a home with seller financing and a wrap-around mortgage has a lot of moving parts from a legal perspective. Whether you're a buyer or a seller, make sure you fully understand the particular deal you're entering if it includes one of these financing tools.

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