A wrap-around mortgage refers to a type of loan transaction. With a wrap-around mortgage, a lender (often the seller of property) assumes or continues responsibility for an existing mortgage and makes a new mortgage for an additional sum which essentially “wraps” around the old mortgage, because the lender will make the payments on the old mortgage.
Joe wants to buy a house from Mary at a purchase price of $100,000. Joe only has $5,000 for a down payment and, because the interest rate he qualifies for on a new mortgage loan is 14%, cannot afford the payments on the remaining $95,000. Mary has an existing mortgage, which is quite old. The interest rate on Mary’s mortgage is 8% and the outstanding balance is $10,000. With a wrap-around mortgage, Mary would offer Joe a mortgage in the amount of $95,000 at 11% interest. The 11% represents a blend between the 14% interest rate available to Joe on a new mortgage and the 8% interest rate attributable to Mary’s existing mortgage. Mary remains responsible for the payments on the existing mortgage. Joe’s new mortgage, on which he makes payments to Mary, “wraps” around Mary’s existing mortgage.
For a lender, a wrap-around mortgage provides a mechanism whereby the lender can make a profit by collecting an interest rate on the wrap-around portion of the mortgage in excess of the interest rate on the existing mortgage. Moreover, a wrap-around mortgage provides many borrowers a financing mechanism that allows them to make a purchase which would not be possible otherwise.
What are the risks?
It is important for a lender, particularly one like Mary in the fact scenario set forth above, to consider why it is a borrower is interested in a wrap-around. Is it because the borrower does not qualify for traditional financing? If so, why? Borrowers interested in wrap-around mortgages may present fairly significant credit risks from the lender’s perspective.
Lastly, it is important to note that a wrap-around mortgage can only be obtained on an existing loan that is assumable. If the existing mortgage is not assumable, a wrap-around mortgage may trigger an acceleration clause which requires the immediate repayment of the entire outstanding amount of the existing mortgage. Thus, it is important to make a careful review of the terms of the existing mortgage before considering a wrap-around mortgage.