Wraparound Mortgage

What Is a Wraparound Mortgage?

A wraparound mortgage — also called a "wrap" — is a creative financing technique where the seller finances the buyer's purchase by creating a new, larger mortgage that encompasses the seller's existing mortgage. The buyer makes a single monthly payment to the seller at an agreed-upon interest rate. The seller then uses part of that payment to continue making payments on the original underlying mortgage and keeps the difference. The buyer gets financing without going through a traditional lender, and the seller earns income from the spread between the two interest rates. Wraps are most commonly used when conventional financing is difficult to obtain or when the seller has a below-market-rate existing mortgage.

How the Rate Spread Works

The seller's profit comes from the difference between the interest rate on the wrap mortgage and the rate on the underlying original mortgage. For example, if the seller's existing mortgage carries a 4% rate and the wrap mortgage charges the buyer 7%, the seller earns a 3% spread on the amount of the existing mortgage. On a $200,000 underlying loan, a 3% spread generates approximately $6,000 per year in interest income for the seller. Additionally, the wrap mortgage is typically larger than the existing mortgage (including the seller's equity), so the seller earns the full 7% on the portion above the existing loan balance. This dual income stream makes wraps attractive for sellers who want ongoing investment returns.

Due-on-Sale Risk

The most significant risk in a wraparound mortgage is the due-on-sale clause present in virtually all conventional mortgages originated since 1982. This clause gives the lender the right to demand full repayment of the loan if the property is sold or transferred. Because a wrap effectively transfers the property to the buyer while leaving the original loan in place, the lender could technically call the loan due. In practice, most lenders do not enforce the due-on-sale clause as long as payments are current, but the risk exists. If the lender does call the loan, the buyer must obtain replacement financing or face foreclosure. This risk should be clearly disclosed and understood by both parties.

Legal Documentation

Proper legal documentation is essential for a wraparound mortgage. The key documents include: a wraparound promissory note detailing the loan amount, interest rate, payment schedule, and maturity date; a wraparound deed of trust or mortgage securing the note against the property; a disclosure of the underlying mortgage terms; an agreement specifying who will service the underlying loan payments; and escrow instructions if a third-party servicer will handle payment collection and distribution. Both parties should have independent legal counsel review all documents. Many states have specific requirements for seller-financed transactions that must be followed to ensure enforceability.

When Sellers Use Wraparound Mortgages

Sellers typically offer wraps in several scenarios: when the property is difficult to sell through conventional channels, when the seller wants ongoing income rather than a lump-sum payment, when the seller has a below-market interest rate they want to monetize, or when the buyer cannot qualify for traditional financing. Wraps are also popular with investor-sellers who want to defer capital gains taxes through an installment sale while earning interest income. The wrap structure allows the seller to remain invested in real estate returns without the responsibilities of property ownership, making it an attractive retirement strategy for landlords looking to exit active management.

Buyer Protections

Buyers in a wraparound mortgage need specific protections. The most critical is ensuring the seller actually makes the underlying mortgage payments. If the seller collects the wrap payment but stops paying the original mortgage, the underlying lender can foreclose — wiping out the buyer's interest. Protections include requiring payments be made through a neutral third-party loan servicer who pays the underlying mortgage first, recording the wrap mortgage to establish the buyer's lien position, requiring the seller to provide monthly proof that the underlying mortgage is current, and including default remedies that allow the buyer to make underlying mortgage payments directly if the seller fails to do so.