Wrap around mortgages allow a buyer to take a new mortgage on a new home without repaying the mortgage on an existing home. This works because the lender issuing the new mortgage will assume the old mortgage on behalf of the borrower. The new mortgage "wraps-around" the old. The new lender does not repay the first mortgage in one lump sum. Instead, the lender pays the mortgage according to the terms the borrower was initially paying.
Example of a Wrap Around Mortgage
Jim has a mortgage of $60,000 remaining on his home. He sells the home for $150,000. This allows him to place $10,000 down on a new mortgage, take a loan for $200,000 from the new lender, and forget about his old mortgage. The new lender will make those payments. Jim can pocket the remainder of the money he earned on the sale. He will pay a slightly higher interest rate on the new mortgage than the old. The lender likes this because the lender will take in high-interest payments from Jim and repay a low interest loan. The lender will keep the difference.
This model only works if a loan is assumable. An assumable loan can be taken over by a new home buyer. Non assumable loans, which are the standard, need to be repaid upon the sale of the home. The lender must approve the deal if the loan will be passed on to a new lender or borrower. Assumable loans do not need to go before the lender first. FHA loans and VA loans are assumable. Many private bank loans, however, are not. The borrower will have to propose the process to a lender, and the initial lender will likely not allow it to occur. The initial lender will typically rather secure prepayment in full.
Wrap around mortgages are typically a form of seller financing. This means the seller of the new home Jim is purchasing is the one providing the mortgage and taking over the old loan. Seller financing is not traditionally provided by an individual. Instead, it is common on homes that are owned by a builder or a bank. For example, a new model home owned by a large construction company may offer seller financing. A home in foreclosure that is currently bank-owned may also have an option for seller financing. Seller financing can simplify the process, and it may even lead to some loan incentives for the borrower.
Yield on Wrap Around Mortgage
The yield on a wrap around mortgage is what makes it attractive for a lender and not always a good idea for the borrower. In the example listed, imagine Jim's initial mortgage was issued at a rate of 5.8%. The new wrap around mortgage may be issued at a rate of 7.5%. Wrap around mortgages must have higher interest rates to function. The lender is earning 7.5% on $90,000 of the loan. The lender is also earning the difference of 1.7% on the two loans, increasing the yield. Jim would have likely saved more if he had gone with a traditional mortgage.