Wrap-Around Loan – Definition

Cite this article as:"Wrap-Around Loan – Definition," in The Business Professor, updated September 5, 2019, last accessed October 20, 2020, https://thebusinessprofessor.com/lesson/wrap-around-loan-definition/.

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Wrap-Around Loan Definition

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.

A Little More on Wrap-Around Loans

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 that’s 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 don’t 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.

References for “Wrap-Around Loan

https://en.wikipedia.org/wiki/Wraparound_mortgage

https://www.investopedia.com › Personal Finance › Home Ownership › Mortgage

www.businessdictionary.com/definition/wraparound-loan.html

Academic research for “Wrap-Around Loan

Selected Problems in Wrap-Around Financing: Suggested Approaches to Due-on-Sale Clauses and Purchaser’s Depreciable Basis, Guerin, S. M. (1980). Selected Problems in Wrap-Around Financing: Suggested Approaches to Due-on-Sale Clauses and Purchaser’s Depreciable Basis. U. Mich. JL Reform, 14, 401.

The Wrap-Around Mortgage: A Critical Inquiry, Schrader, W. A. (1973). The Wrap-Around Mortgage: A Critical Inquiry. UCLA L. Rev., 21, 1529.

The Wrap-Around Deed of Trust: An Answer to the Allegation of Usury, Arditto, M. A. (1979). The Wrap-Around Deed of Trust: An Answer to the Allegation of Usury. Pac. LJ, 10, 923.

A Tax Policy Analysis of Wrap-Around Financed Installment Sales, Guerin, S. M. (1983). A Tax Policy Analysis of Wrap-Around Financed Installment Sales. Va. Tax Rev., 3, 41.

Eroding the Tax Benefits of Wrap-Around Annuities: An Analysis of Revenue Ruling 81-225, Petrie, G. (1981). Eroding the Tax Benefits of Wrap-Around Annuities: An Analysis of Revenue Ruling 81-225. U. Fla. L. Rev., 34, 95.

When Wrap-around Mortgages Return-The Time to Plan Is Now, Harp, R. K. (2004). When Wrap-around Mortgages Return-The Time to Plan Is Now. Prob. & Prop., 18, 42.

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