A mortgage loan transaction in which the lender assumes responsibility for an existing mortgage.
Usually, but not always, the lender is the home seller. For example, S, who has a $70,000 mortgage on his home, sells his home to B for $100,000. B pays $5,000 down and borrows $95,000 from S on a new mortgage. This mortgage “wraps around” the existing $70,000 mortgage because S will continue to make the payments on the old mortgage.
Awrap-around can be attractive to home sellers because they may be able to sell their home for a higher price. In addition, if the current market interest rate is above the rate on the existing mortgage, the seller can earn an attractive return on the cash foregone from the sale. For instance, if the $70,000 mortgage in the example has a rate of 6% and the new mortgage for $95,000 has a rate of 8%, S earns 8% on his $25,000 investment plus the difference between 8% and 6% on $70,000. The total return is about 13.5%. I have a spreadsheet on my Web site that calculates the yield on a wrap-around.
But the high return carries a high risk. The new mortgage owned by S is a riskier asset than the house he previously owned. The new owner has only $5,000 of equity in the property. If a small decline in market values erases that equity, the owner has no financial incentive to maintain the property. If the buyer defaults on his mortgage, S will be obliged to foreclose and sell the property in order to pay off the old mortgage.
Only assumable loans are legally able to be wrapped. Assumable loans are those on which existing borrowers can transfer their obligations to qualified house purchasers. Today, only FHA and VA loans are assumable without the permission of the lender. Other fixed-rate loans carry “due on sale” clauses, which require that the mortgage be repaid in full if the property is sold.
Sometimes wrap-arounds arise on loans with due-on-sale clauses without the knowledge of the lender. This is looking for big trouble. See Assumptions/Illegal Assumptions/Wrap-Arounds.