Wrap-Around Loan - Explained
What is a Wrap-Around Loan?
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Table of ContentsWhat is a Wrap-Around Loan?How Does a Wrap-Around Loan Work?Example of a Wrap-Around LoanExample of a wrap-around loanThings to consider for a wrap-around loan
What is a Wrap-Around Loan?
A wrap-around loan refers to a mortgage loan that one can use in owner-financing contracts. It includes the home mortgage of the seller and further includes an additional amount to determine the total purchase price that the seller should receive in a given time frame. A wrap around depends on the seller-financed contracts used on a general basis. Such kind of loan has similar features like a seller-financed loan, except it represents the current loan of the seller.
How Does a Wrap-Around Loan Work?
Seller financing refers to a form of financing that lets the buyer to make payment of the principal amount straight to the seller. Such deals tend to be risky for the seller, and thats why they involve above-average down payments. A seller-financed deal takes an agreement, formed on the basis of a promissory note, into consideration. This agreement states the financing terms and conditions involved. Also, such deals dont ask the buyer for the upfront payment of principal amounts. Instead, he or she pays installment including principal amount and interest thereon, to the seller. Wrap-around loans are formed on the theory of owner-financing, and use a similar structure. Such structure is applied in an owner-financed agreement in which the seller still has to pay the due amount on the mortgage taken for the first property. The wrap-around loan considers the due amount on the current mortgage of the seller at its agreed mortgage rate, and further, includes an added balance for determining the total purchase price.
Example of a Wrap-Around Loan
A wrap-around loan considers the current mortgage loan for arriving at the base rate of interest for the seller. For achieving a break-even position, the seller must ensure to receive at least a certain amount of interest that is equivalent to the loan rate, that still needs to be paid off. Hence, a seller can have the authority or privilege for negotiating the interest rate of buyer depending on the present conditions. Usually, it will be the first preference of the seller to close the deal at the maximum interest rate so that he or she can pay the first mortgage, and also gain a spread from the contract. As the seller takes on the complete responsibility of default risk on the mortgage, it increases their risks associated with wrap-around loans.
Example of a wrap-around loan
For instance, Joyce takes a home mortgage of $80,000 for her home, and the rate of interest on mortgage is 4%. She further makes the sale of home to Brian for a whopping amount of $120,000. Brian pays 10% as a down payment, and agrees to pay the remaining amount of $108,000 at an interest rate of 7%. Now, Joyce makes 7% on 28,000 that is the difference between $108,000 and $80,000, plus the difference between the given interest rates, 7% and 4% on the mortgage of $80,000.
Things to consider for a wrap-around loan
Wrap-around loans bear more risk for sellers as they may have to pay complete amount of loan in case the buyer fails to pay. It is important for sellers to know that their present mortgage should exclude an alienation clause that asks them for making the 100% repayment to mortgage lending institution in case there is a transfer in collateral ownership or sale of the collateral security. Such clauses are usually seen in mortgage loans which hinder the occurrence of the wrap-around loan deals.