Wraparound Mortgage - Real Estate - USA 

A wraparound mortgage is a mortgage that has one or more properties as security to the amount of the loan, and the total amount of the loan is a combination of the new loan, and one or more existing loans. This type of loan is often held by a seller and can be called a purchase money wraparound mortgage. 

Example

Bill is selling an apartment building he owns for $250,000 to Frank. Frank wants to put $75,000 down and structure the financing so that his annual payments on the balance owed of $175,000 and set up the finacing so that his interest payments do not exceed $22,000 per year. Current interest rates in the market are at about 9.75 to 10.50 per annum. Frank is prepared to accpt such financing as long as there is at least ten years of fixed payments before a ballon would be due. Currently on the property the following financing is in place. 

• A first mortgage in the amount of $50,0000 that was the original mortgage Bill had when he purchased the property ten years earlier. This mortgage will amortize in full in eight years at $706 per month. The interest rate is 8% per annum. 
• A second mortgage in the amount of $90,0000 that Bill had obtained 10 years ago. This mortgage will amortize in ten years. The monthly payments on this mortage are $1,115 per month. 

Bill tells Frank that he will create a purchase money wraparound mortgage in the amount of $175,000 at an interest rate of 9.75% and that the monthly payments will be approximatley $1822 per month. This equates to roughly $21,864 per year. This mortgage will have a term of ten years and at the end of the term there will be a balloon payment of about $94,000.

So in order for Bill to meet his all his mortgage obligations on on his first 2 mortgages he is dependent on Frank to make the payments on the $175,000 mortgage to Bill who then in turn makes the payments on the 2 mortgages. So we have the following

The first mortgage of $50,000 which has a monthly payment of $706.00

The second mortgage of $90,000 has a monthly payment of $1,115.00

What this means is that until the first mortgage is paid off which is 8 years, Bill will not get any money extra money in his pocket. Then for a 2 year period, he will be able to put into his own pocket the portion that was previously going to the first mortgage. is is 706 per month for 2 years (24 month) or a total of $16,964. Then at the end of the ten year payment schedule that Bruce is obligated to, there is a balloon payment due of $94,000

Therefore Bill ends up with 

Payments for years 9 and 10 after the first mortgage is paid off: $16,944 

The Balloon payment (because the second mortgage was fully paid off) $94,065.00

For a total of $16,944 + $94,000 = $110,944

Keep in mind that the portion of the $175,000 that consisted of Sams Equity in the mortgage is about $35,000. ($175,000 minus the first mortgage of $50,000 and less a second mortgage of $90,000 = $35,000.

This means that for a $35,000 investment Bill would have received approximately $110,944 over the ten year period and even perhaps a little more because he can take his cash flow in 9 and 10 and invest them again. 

The actual yield on the $35,000 invested by Bill  in this mortgage was leverraged by the the spread between the existing mortgages (which were 8 and 8.5% per annum respectively.) The easiest approach to find the yield would be to assume that Bill didnt take any money until the end of the tenth year. The compound interest it would take to increase $35,000 to $110,944 is about 12.2% per year. However one must remember that Bill did get some of the returrn (almost half the original $35,000), earlier, so his ultimate yield would be higher. The consequence is that Bill ends up with a leveraged return. Frank also wins on the deal because he gets a mortgage that was at current interest rates, and he did not have to pay mortgage points to any lender, and was able to make the deal at a price and terms that he was comfortable with. 

There are several different kinds of yields that are available in a wraparound mortgage. There is the effective yield and the average yield. We can use another example to explain these yields. 

Tom wants to buy Brians House for $120,000 and there is a 1st Mortgage on the house worth $50,000. This loan is payable over 20 years at a fixed interest rae of 8.5% per annum, with a monthly payment of $433.

Tom offers Brian a down payment of $25,000 and agrees to offer a second mortgage of $45,000 at an interest only payment of 10% for 10 years with a ballon payment at that time, with assumption of the existing mortgage. Under this loan arrangement Tom would have a combined monthly payment of the 2 mortgages of $809.00

Brian makes a counter offer by offering to take the $25,000 down payment and hold a $95,000 wraparound mortgage with a 10% interest only payment for 10 years with the principal amount of the mortgage coming due at the end of the ten years. Under these conditions. Tom must make a monthly payemnt of $791.00. As you can see Tom is making a payment that is less than his own original offer. Therefore Tom is likely to accept to accept Toms deal.

As far as Tom is concerned, the wraparound means that Brian is holding one mortgage in the amount of $95,000. However from Brians point of view there are 3  mortgages.

1. There is an existing mortgage of $50,000 which has a monthly payment of $433 per month for 20 years.

2. The wraparound mortgage which is for $95,000 which has a monthly payment of Tom to Brian of $791

3. The Sellers Equity in the wraparound mortgage. This is the difference between the wraparound mortgage and the existing mortgage.

The wraparound mortgage of $95,000 minus the $50,000 gives Brian a difference of $45,000. In practice Tom is paying as if he held a single $95,000 mortgage that was intererst only for 10 years. While Brian is continuing to make payments on his existing mortgages and puts the difference in his pocket. Since he collects $791 and pays out $433 per month he as a difference of roughly $433 per month. This adds up to roughly $4293 per year which is an interest rate of 8.59% per annum on the difference of $45,000 difference. 

However since the wraparound mortgage paid by Tom is interest only, and the existing mortgage paid by Brian is being paid off slowly. At the end of the year the size of the mortgage he owes Brian is still $95,000 while on the other hand over the 10 year period Brian will have completely paid of his existing mortage but Tom still owes the original $95,000.

At the end of the first 12 months the original $50,000 mortgage is paid down to $49,000. This would put another $993 in Brians hands if the mortgage were paid off at that time. This would increase Brians cash in pocket to a total of $5,286 and his yield to roughly 11.75% per year. 

Tom gets a benefit of decreased debt payments, and at the same time Brian benefits because he increased his overall effective yield on the wrap. 

Some Rules about the Wraparound

The nature of the wraparound mortgage causes the situation to keep the existing financing on the properrty. Therefore it is possible for two wraparounds to be placed on a particular properrty.

To give an example of this consider a property that Michael wants to buy. The current financing has a wraparound in the the amoung of $100,000 which consists of a first mortgage of $60,000 and therefore the difference is $40,000. In addition to thei wraparound the seller placed another mortgage on the property a few years ago in the amount of

$25,000. This would be considered the third mortgage as their is a rank of mortgages at this point. This would be (1) The existing first mortgage (2) the wraparound (3) the $25,000 mortgage. So this transaction  the seller would hold a fourth mortgage for $35,000. The seller could do exactly that, or he would have the following options that would involve new forms of wraparound mortgages. There the current situation would look like this.

1st. wraparound: $100,000 (Which consists of the ($60,000 original mortgage plus the $40,000 difference)

3rd mortgage of $25,000

Difference between the mortgages is  $35,000

2nd wraparound $160,000 (this is the previous mortgages total plus the difference)

In this situation Michael would make one payment on the second wraparound of $160,000 and the seller inturn would continue to makey the payments on the first wraparound. (this would include the first mortgage payment and the difference of $40,000), he would also in turn make the mapyments on the third mortgage. He would ultimatly keep the balance left over which would be the difference between all these mortgages that he is paying and the amount he receives from Michael. 

Therefore it is important to keep one thing in mind regarding wraparound mortgages. A wraparound mortgage is not required to enclose all existing mortgages. This is an important point because if you by a property with a wraparound do not assume that there are no other mortages you need to pay. An important part of any real estate transaction is you know exactly what debt there is against the property you are buying. The only way to know for sure is if a title search is made by your lawyer or title company. However, also the seller will need to acknowledge that the are no hidden loans on the property.