A Brief Introduction of Wrap Around Mortgage Contract
An individual wishes to buy a new home, but he cannot get good credit. The seller wishes to sell his home, but he is not able to find good buyers. The seller to make this transaction happen enters into a wrap around mortgage contract. Through this contract, the seller sells his property by creating a new mortgage on the buyer with an interest rate higher than his existing loan.
The buyer accepts the charge and remits the monthly payments of interest and principal to the seller regularly. The seller, in turn, pays them to the original lender of his old loan. He pockets the difference of interest obtained as income. However, the seller should obtain prior approval of his lender for entering into a wrap around financing arrangement.
Who Takes the Wrap Around Mortgage Contract?
- Seller – The seller of a real estate property normally an individual. Institutional sellers or lenders do not offer such type of financing in most of the cases. He creates a benefit for all the parties in the transaction but with caution.
- Buyer – The intended buyer of the property. He is an individual struggling to obtain credit for his proposed purchase. He agrees to pay a slightly higher rate of interest but nothing more than the prevailing market rates.
- Banker/Original lender – Though he does not sign a wrap around mortgage, he is an important party to this relationship. The seller cannot enter into this contract without his prior approval. The original lender has the primary recourse to the property always. He is the watchdog of a wrap around financing relationship, and the primary loan agreement forms the basis of this contract.
Purpose of a Wrap Around Mortgage Contract
The very purpose of entering Wrap Around Mortgage Contract is to ensure all the parties to the agreement receive what they deserve.
We can understand this better by a wrap around mortgage example. A seller wishes to sell his property. He already has an outstanding mortgage of $25,000 with his banker on the property. On the other hand, a buyer wants to purchase the property but not able to find standard lenders. So the seller, after consulting with his banker, creates a wrap around mortgage on the property for $275,000 as the buyer makes a down payment of $25,000. The buyer is provided financing at a rate of 5% against the seller’s rate of 3.5%. The buyer makes the installment payments every month to the seller, and he, in turn, makes the payment to the banker.
Contents of a Wrap Around Mortgage Contract
- The wrap around loan agreement should state that it is an addendum to the already existing security instrument/mortgage. The borrower of the mortgage, the original principal amount, date of borrows, the region of jurisdiction, and all the other details which the parties may deem necessary shall be included.
- The contract shall mention the details of the individual in whose favor the new mortgage is created.
- The obligations and liability of the borrower towards the seller and the banker or the primary lender.
- The liability of the seller towards the original mortgage.
- A clause to authorize the buyer to make payments to the primary lender in case of defaults by the seller.
How to Draft the Wrap Around Mortgage Contract?
The contract proves to be a good alternative source of financing. But the risks pertaining to the relationship outgrow the benefits derived from it. Hence the buyer shall make proper research on the counties for legitimate sellers. It is imperative on the part of the buyer to insist on getting the transaction documented as a legally enforceable one.
Though the purpose of obtaining a wrap around loan is to avoid brokerage, commission, and other additional expenses for getting the credit, it is suggested to seek the advice of an attorney before entering into such contracts. He will be able to gauge the risks and benefits of the mortgage appropriately and suggest a further course of action.
The one important factor the buyer of a home should consider while negotiating is requesting the seller to include a clause in the contract where he is authorized to pay to the lender of the seller directly in case the seller defaults in payment. This prevents foreclosure and losing heavily on the property purchase.
Benefits and Drawbacks of a Wrap Around Mortgage Contract
The benefits of entering a wrap around financing agreement are
- A wrap-around mortgage helps buyers with weak credit limit to become homeowners. By not approaching institutional lenders, they can avoid having to pay higher interest for any subprime loan that they would’ve gotten.
- A seller can ensure the sale of his house especially in a bad housing market, or low rate housing areas. By using a wrap around mortgage, the seller doesn’t have to wait for buyers getting approved by the lenders
- A seller can make a difference on interest rates as profit until his mortgage is paid off. After it is paid off, the entire interest rate is his profit. This ensures that the time value of money is preserved and you don’t have idle funds lying about
- For a buyer, with his credit services and the interest rate market, he gains if the interest is higher outside. For example, for his credit level, if the market rate is 10% and the seller is charging 8%, he stands to gain the 2% interest on payments
- The foremost benefit – making finance available for everyone and utilizing the idle value of a property.
- The agreement, in some cases, is entered by a seller who defaults in payment to the lender. Hence the wrap around mortgage works as a suitable mode of alternative financing.
- The banker or the institutional lender and the original mortgage serve as a checkpoint for both the buyer and the seller in making the payments promptly.
A wrap around mortgage comes with huge risks to the
- Buyer – when the seller defaults in payment, the lender exercises the lien on the property, and the innocent buyer loses heavily in the transaction.
- Seller – The default on the part of the buyer shall impact the creditworthiness of the seller. Continuous defaults shall force the banker to foreclose the mortgage.
What Happens in Case of Violation?
Violation(1) of a wrap around mortgage agreement can lead to huge financial losses for both the buyer and the seller. All the payments made towards the discharge of mortgage become futile, and the primary lender forecloses the mortgage. This impacts the credit score of the parties to the agreement, making it very difficult for them to obtain any other form of credit. If the seller holds an array of properties, it impacts the saleability of other properties too.
However, the primary lender gives a cooling period to bring the defaults on track. The parties in default shall duly consider the remedies given by the primary lender and avoid foreclosures.
A wrap around mortgage agreement is too risky as the buyer is indirectly imposed to oblige the various clauses of the primary mortgage. Seeking the help of a real estate attorney for entering into the contract can be a wise choice. This helps in exercising the right options and making informed decisions.