A wraparound mortgage encompasses existing mortgages and is subordinate or junior to them. The existing mortgages stay on the property and the new mortgage wraps around them. This is an attractive alternative method of financing a real estate investment venture.
To illustrate, presume the existing mortgage explain in the previous example, Purchase Money Mortgage, carries an interest rate of 7% and that there are 15 years remaining on the loan. Presume further that current interest rates are 11%. With a wraparound it is possible for the buyer to pay less than 11% and at the same time for the seller to receive more than 11 % on the money owed him. This is done by taking the buyer’s $60,000 down payment and then creating a new junior mortgage that includes not only the $20,000 owed on the existing first mortgage, but also the $40,000 the buyer owes the seller. In other words, the wraparound mortgage will be for $60,000, and the seller continues to remain liable for payment of the first mortgage. If the interest rate on the wraparound is set at 10%, the buyer saves by not having to pay 11% as he would on an entirely new loan. The advantage to the seller is that he is earning 10% not only on his $40,000 equity, but also on the $20,000 loan for which he is paying 7% interest. This gives the seller an actual yield of 11 1/2% on his $40,000. (The calculation is as follows. The seller receives 10% on $60,000, which amounts to $6,000. He pays 7% on $20,000, which is $1,400. The difference, $4,600, is divided by $40,000 to get the seller’s actual yield of 11 1/2%.)
Wraparounds are not limited to seller financing. If the seller in the above example did not want to finance the sale, a third party lender could provide the needed $40,000 and take a wraparound mortgage. The wraparound concept will not work when the mortgage debt to be “wrapped” contains an enforceable alienation clause.
Wraparound To Subordination