If you don’t have enough for a down payment or your credit history has too many dings, finding a seller who will offer owner financing may be your only option to purchase a home. There are several types of owner financing arrangements including the risky wrap-around mortgage. Although you may be eager to take whatever deal a seller offers, never write a check or sign any papers until you have consulted an attorney for advice.
Traditional mortgages involve you borrowing money from a bank or other financial lender to pay for your new home. A wrap-around mortgage, however, is a type of seller financing that normally involves only you and the home’s seller, bypassing conventional lenders. Let’s say that Mr. Smith has a home with a $100,000 mortgage on it at 6.0 percent interest and he is willing to sell it to you with a wrap-around mortgage for $200,000--$20,000 as a down payment and the rest in scheduled payments at 8.0 percent interest, for example. While the original mortgage on the house remains intact, the seller uses the money that you pay him to pay the original mortgage, so your mortgage with the seller actually “wraps around” the original mortgage.
Wrap-around mortgages give buyers who might not meet a lender’s requirements for a mortgage the opportunity to purchase a home. If you don’t have the entire down payment, sellers sometimes allow you to split the down payment with a portion due at closing and the rest due at a later date. From a seller’s perspective, offering seller financing may make her home more attractive in a slow housing market. There is also some financial incentive for sellers since they reap the benefits of charging a higher interest rate than they are actually paying their own lender.
One of the biggest risks for all parties involved in a wrap-around mortgage involves who is paying the original lender. If the seller allows the buyer to pay the first mortgage directly or through a third party, the seller may not be notified until it is too late that a mortgage payment is late or has been missed which can ruin his credit and put the mortgage in jeopardy. The Traub Law Firm calls this an “extremely risky arrangement for the seller, who remains liable for the original loan.” If the seller pays the first mortgage, you as the buyer would have to trust that the seller is actually making those payments. If the seller defaulted on the first mortgage, foreclosure could take place and you risk walking away with nothing.
Wrap-around mortgages are only allowed on mortgages that are “assumable”--a restriction placed by the lender that no one else can be held accountable for the loan except the original borrower. Most bank-backed lending institutions do not allow assumable mortgages. In fact, in 2010, the only assumable mortgage loans were those made by the FHA and VA. If a lender discovers that a wrap-around mortgage has taken place, they could call the entire loan balance due or, best-case scenario, they could recalculate the loan at current interest rates and charge a hefty fee for the privilege. In addition, some states legally prohibit wrap-around mortgages altogether.
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