Dangers of a Wrap-Around Mortgage

A wrap around mortgage is a second loan a home owner makes to a prospective buyer to help him purchase the home. It can help close a sale when a borrower doesn't qualify for a traditional loan. But there are dangers for both the lender and the borrower. The following information will explain what a wrap around mortgage is and the chief risks.

What Is a Wrap Around Mortgage?

A wrap around mortgage is a home loan from a home owner to a prospective buyer that "wraps around" the existing mortgage on the home. The home buyer then pays a monthly mortgage payment to the home seller and the home seller continues paying on the original mortgage.

The seller has two benefits in a wrap around mortgage:

    * In a slow housing market, lenders often are more stringent in enforcing credit standards making it harder for marginal borrowers to get home financing. A wrap around mortgage can help get a house sold because it is, in effect, owner financing.
    * The home seller typically charges a higher interest rate than he has on the existing mortgage and makes money on the difference.

For the home buyer, a wrap around mortgage offers a way to get into a home when traditional financing avenues are closed.

Due on Sale

The chief danger of the wrap around mortgage is to the seller. Most mortgages have a "due on sale" clause. This means if the house is sold, the entire mortgage balance is due. If the seller cannot pay that amount or borrow it and pay it, the lender could foreclose on the home.

The due on sale clause is not always enforced, but sellers must be aware of it.

Borrower Default

The seller has also taken on all of the risk of a traditional lender in a wrap around mortgage.  If the borrower doesn't pay, the seller bears all the costs associated with enforcing the loan or foreclosing.

Additionally, if the borrower doesn't pay, the seller is then at risk of being unable to pay his mortgage and could face foreclosure. This can occur even though the borrower is causing the problem by not paying. The wrap around is a second mortgage and as such is in a second position for enforcement. If the seller cannot pay the first mortgage, even when it is the home buyers fault, the original mortgage lender has the first claim and can foreclose on the original home owner.

Lender Default

Risks of a wrap around mortgage are not limited to the seller. The buyer faces default risk as well. As an example, if a buyer consistently makes monthly payments, but the seller is not then paying the first mortgage, the original mortgage lender can foreclose on the home.

Legal Issues

The lender also bears the risk of having loan documents properly prepared and executed so that he can take action if the borrower defaults. Additionally, if there is profit on the loan it could be a taxable event for the seller. A wrap around mortgage can help sell a home in a down market, but it is accompanied by multiple dangers for buyer and seller.