If attempts to get on the property ladder have been stymied by high financing costs, an answer may be “living” within your future home.
For those seeking an alternative route to homeownership, wraparound mortgages may just be the answer. Here’s a look at this innovative financing option that’s tailored for first-time buyers and others seeking to get their dream home.
A wraparound mortgage is a financing method that allows consumers to buy a property without securing a traditional mortgage. It starts with the current homeowners and their existing mortgage.
Buyers agree to pay off the mortgage – plus fees set by the seller – by paying the current homeowner who continues to hold the mortgage debt. The seller of the property receives a secured promissory note, a fancy term for a legal IOU, which details the reshaped loan (principal and interest).
The seller continues to make mortgage payments while collecting surplus from the buyer as profit. Sellers typically make the offer to sell in a buyer-favorable market when the current mortgage environment is less than welcoming to some buyers and/or to allow the seller to monetize the home transaction beyond the sales price.
While buyers won’t have legal title to the property (that remains with the lender), they gain equitable title, allowing them to occup the property. Legal title is transferred from lender to mortgage holder after the home is paid off and then shifted to the buyer after the wraparound loan is fully paid.
Wraparound mortgages are generally legal in Washington as long as both parties willingly agree to the terms under the law. However, it’s vital to seek legal counsel and draft a clear agreement to protect all parties involved in the deal.
Wraparounds offer several advantages to homebuyers, especially those struggling to meet traditional financing criteria:
- Easier Qualification. They are more accessible for buyers who may not meet conventional lenders’ stringent requirements.
- Flexible Terms. You and the seller can negotiate terms that work for both parties, including interest rates and repayment schedules.
- Faster Homeownership. The process of obtaining a wraparound mortgage is often faster and involves fewer administrative hurdles than a traditional mortgage.
While wraparound mortgages can be a lifeline for young buyers, they also carry risks:
- Interest Rate Risk. If the seller’s existing mortgage has an adjustable interest rate, it could lead to uncertainty when the rate changes and, if a higher rate, the burden could be placed on the buyer.
- Default Risk. If the sellers fail to make payments on their original mortgage, it could lead to foreclosure, jeopardizing the buyer’s investment.
- Cancel Risk. The seller can begin a long legal process to cancel – or forfeit – the agreement if the buyer fails to follow the terms.
- Due-on-Sale Clause. The seller’s mortgage may contain a due-on-sale clause, triggering repayment of the full mortgage amount upon property sale, potentially complicating the wraparound arrangement.
In addition to being used by some first-time buyers, wraparounds are useful for consumers with a limited credit history or minimal down payment. They are also seen when sellers, possibly facing cash difficulties, want to offload their property swiftly and are open to flexible financing options.
Wraparounds should not be confused with an assumable mortgage, which requires the buyer to work with the same lender of their seller’s mortgage. In an assumable mortgage, the new homeowner assumes responsibility for the seller’s loan.
Buyers that use a wraparound do not work directly with the financial institution; the seller could be considered “the bank” and must seek permission from the state’s Department of Financial Institutions before completing the arrangement. The lender continues to pay down the mortgage and the servicer will adjust for taxes and fees, assuming the seller continues to make payments.
Sellers typically continue to pay for homeowner’s insurance with the buyer reimbursing them. They should not stop coverage or it will trigger a red flag to the lender that “an event” has occurred and potentially risking a call to pay off the loan. Financial judgments against the seller do not fall back on the buyer and should not affect the validity of the new owner’s title.
To maximize the benefits of a wraparound mortgage, interested buyers should conduct thorough research, speak with a real estate attorney and ensure financial goals still align with this creative – but risky – approach.
Attorneys, rather than real estate brokers, are more qualified to draft the purchase-and-sale agreement as well as the terms of the loan. Unless they have a law degree, brokers cannot directly execute these types of arrangements.
Wraparound mortgages can be a valuable tool for aspiring homeowners in Washington state, offering an alternative to the conventional 30-year mortgage.
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