Wraparound Mortgages Explained: How Wraps Work in Real Estate and When to Use Them

A wraparound mortgage is a form of creative financing where a new loan "wraps around" an existing mortgage. The seller creates a new, larger mortgage for the buyer that includes—and encompasses—the balance of the seller's existing loan. The buyer makes one payment to the seller, and the seller uses part of that payment to continue paying their original mortgage.

The seller profits from the spread between the two interest rates. The buyer gets financing without qualifying for a traditional bank loan. And the existing mortgage stays in place—quietly being paid down by the transaction.

Wraparound mortgages sit at the intersection of [seller financing](/blog/seller-financing-guide) and subject-to deals. If you understand both of those strategies, wraps are the logical next step.

How a Wraparound Mortgage Works

Let's start with a concrete example:

The existing situation:

• Property value: $350,000
• Seller's existing mortgage: $200,000 at 4.0%, with monthly P&I payment of $955
• Seller has $150,000 in equity

The wraparound deal:

• Sale price: $340,000
• Buyer's down payment: $30,000
• Wraparound mortgage: $310,000 at 7.5%
• Wraparound monthly P&I: $2,168 (30-year amortization)
• Balloon payment: Remaining balance due in 7 years

The monthly cash flow:

• Buyer pays seller: $2,168
• Seller pays existing mortgage: $955
• Seller keeps the spread: $1,213 per month

The seller earns interest on the full $310,000 at 7.5%, but only pays interest on $200,000 at 4.0%. The 3.5% spread on the underlying $200,000, plus 7.5% on the $110,000 above the existing loan, creates significant yield for the seller.

The Yield Is Higher Than It Appears

The seller's effective yield on their equity is substantially higher than the stated 7.5% rate. Here's why:

They're earning 7.5% on money they didn't actually lend (the $200,000 existing mortgage balance) while only paying 4.0% on it. That 3.5% spread on $200,000 generates $7,000/year in additional income.

On their actual equity of $110,000 (the $310,000 wrap minus the $200,000 existing mortgage), the return is:

• Interest earned on wrap: ~$23,250/year (7.5% × $310,000)
• Interest paid on existing: ~$8,000/year (4.0% × $200,000)
• Net interest income: ~$15,250/year
• Return on equity: ~13.9% ($15,250 ÷ $110,000)

That's a compelling yield for the seller—far better than the 7.5% headline rate suggests.

Wraparound vs. Subject-To vs. Seller Financing

These three strategies overlap significantly but have important differences:

Key advantage of wraps over straight subject-to: In a wraparound, the seller continues to make the underlying mortgage payment. This gives the seller more control—they know the payment is being made because they're making it. In a subject-to deal, the seller has to trust that the buyer is making payments on a loan that's still in the seller's name.

When Wraparound Mortgages Make Sense

For Sellers

1. You want ongoing income with a great yield. The interest rate spread creates returns well above what the stated rate would suggest.
2. You have a low-rate mortgage worth preserving. If you have a 3–4% mortgage from 2020–2021, paying it off means losing a valuable asset. A wrap lets you keep it and profit from it.
3. You want to sell in a tough market. Offering wraparound financing expands your buyer pool dramatically.
4. Tax deferral. Like other installment sales, wraps allow you to spread capital gains over the life of the note.
5. You want to maintain control. Unlike subject-to, you keep making the underlying mortgage payment, so you know it's getting paid.

For Buyers

1. You can't qualify for a conventional loan. Self-employed, credit issues, recent job change—wraps bypass bank underwriting.
2. The effective rate is still attractive. Even at 7–8%, if the alternative is hard money at 12% or not buying at all, the wrap works.
3. Speed and simplicity. No bank approval, no 45-day timeline, no PMI.
4. Lower closing costs. No origination fees, no appraisal required (though recommended), minimal lender fees.

How to Structure a Wraparound Mortgage

Step 1: Verify the Existing Mortgage

Before structuring a wrap, confirm:

• Exact loan balance, interest rate, and payment amount
• Whether the loan is current
• The due-on-sale clause language
• Whether the loan is conventional, FHA, or VA
• Remaining term
• Any [prepayment](/blog/heloc-prepayment-penalty) penalties

Step 2: Set the Wrap Terms

Sale price: Market value or negotiated price (sellers offering creative financing often command near-full market value).

Down payment: Typically 5–20%. The down payment goes directly to the seller as equity.

Wrap interest rate: Must be higher than the underlying mortgage rate for the seller to earn a positive spread. In the current market, 7–9% is typical for wraps on properties with underlying loans at 3–5%.

Amortization: Usually 25–30 years to keep payments manageable.

Balloon: 5–10 years is standard. The buyer refinances or sells before the balloon comes due.

Payment structure: The buyer makes one payment to the seller (or a third-party servicer). The seller (or servicer) then makes the payment on the underlying mortgage.

Step 3: Use a Third-Party Loan Servicer

This is essential for wraparound mortgages. A third-party servicer:

• Collects the buyer's payment
• Makes the underlying mortgage payment on behalf of the seller
• Holds escrow for property taxes and insurance
• Provides payment history and year-end tax documents
• Protects both parties by ensuring the underlying loan gets paid

Cost: $25–$50/month. This is the best money spent in the entire transaction.

Without a servicer, the buyer has no assurance the seller is making the underlying payment. And the seller has no professional record-keeping system. A servicer eliminates the trust problem.

Reputable servicers include FCI Lender Services, Universal Mortgage Servicing, and various regional servicing companies.

Step 4: Document the Deal

Required documents (prepared by a [real estate attorney](/blog/how-to-build-real-estate-team)):

1. Purchase and sale agreement with wraparound financing terms
2. Wraparound promissory note detailing the wrap amount, rate, payment, balloon date, late fees, default provisions, and prepayment terms
3. Wraparound mortgage or deed of trust (recorded with the county, in junior position behind the existing mortgage)
4. Disclosure statement informing the buyer about the underlying mortgage—balance, rate, payment, and the due-on-sale risk
5. Servicing agreement with the third-party loan servicer
6. Title insurance protecting the buyer's ownership interest

Transparency is critical: The buyer must know about the underlying mortgage. In many states, failing to disclose the existing loan is fraud. Full disclosure protects everyone and is the right thing to do.

Step 5: Close and Record

The closing transfers the deed to the buyer and records the wraparound mortgage. The existing mortgage remains in place and continues to be paid through the servicer.

The Due-on-Sale Clause in Wraparound Deals

Wraparound mortgages carry the same due-on-sale risk as subject-to transactions. The property is being transferred while the existing mortgage remains in place, which technically triggers the due-on-sale clause.

All the same mitigation strategies apply:

• Keep the underlying mortgage current
• Consider a land trust structure
• Have a refinance exit strategy ready
• Understand that lenders rarely accelerate performing loans, but the risk isn't zero

Additional wrap-specific consideration: In a wrap, the seller continues making the underlying payment, which means the lender sees uninterrupted, on-time payments from the original borrower. This arguably makes detection and acceleration less likely than in a subject-to deal where payment patterns might change.

Risks and Protections

Buyer Risks

1. Seller stops paying the underlying mortgage. This is the biggest risk. If the seller collects your payment but doesn't pay the underlying mortgage, the first mortgage goes into default. Mitigation: Use a third-party servicer who pays the underlying loan directly.

2. Seller files bankruptcy. The property and the underlying mortgage could be pulled into bankruptcy proceedings. Mitigation: Proper [documentation](/blog/heloc-documentation-requirements), title insurance, and potentially a performance deed of trust.

3. Due-on-sale acceleration. The underlying lender calls the loan due. Mitigation: Have refinancing lined up as a backup plan.

4. Balloon payment. You need to refinance or sell before the balloon date. Start planning 12–18 months in advance.

Seller Risks

1. Buyer defaults. The buyer stops paying, and you have to foreclose on the wrap while continuing to pay the underlying mortgage. Mitigation: Require a meaningful down payment (10%+) and verify the buyer's ability to pay.

2. Liability on the underlying mortgage. Your name stays on the original loan. If something goes wrong, your credit is at risk. Mitigation: The third-party servicer ensures the underlying payment is made first.

3. Deficiency risk. If you have to foreclose and the property has declined in value, you might not recover the full balance. Mitigation: Conservative LTV on the wrap and adequate property insurance.

Legal Considerations by State

Wraparound mortgage laws vary by state:

• Texas has specific provisions under the Texas Property Code (Chapter 5, Subchapter D) for executory contracts and wraps. As of 2005, Texas law requires extensive disclosures and gives buyers significant protections, including the right to cancel within 14 days.
• [California](/blog/california-heloc-guide) calls wraps "All-Inclusive Trust Deeds" (AITDs) and has well-established case law supporting their use.
• Some states (Minnesota, for example) have restrictions on certain types of contract-for-deed and installment sale arrangements that could affect wrap structures.

Always consult a real estate attorney in your state before structuring a wraparound mortgage.

Dodd-Frank and Wraparound Mortgages

The same Dodd-Frank rules that apply to seller financing apply to wraps:

• If the seller finances more than 3 properties in 12 months, they likely need to use a licensed mortgage loan originator
• Balloon payments on owner-occupied properties may require MLO involvement
• The ability-to-repay standard applies to consumer-purpose loans

Investment property transactions are generally exempt from the most restrictive Dodd-Frank provisions, but the rules are complex. Legal counsel is essential.

Advanced Wrap Strategy: The Double Wrap

In a double wrap (or "wrap within a wrap"), an investor buys a property subject-to the existing first mortgage, wraps it with seller financing to a new buyer, and profits from the layered spreads.

Example:

1. Existing first mortgage: $180,000 at 3.5%
2. Investor buys subject-to from the original owner
3. Investor sells to end buyer with a wraparound mortgage: $270,000 at 8.0%
4. Investor earns the spread on $180,000 (4.5%) plus full interest on the $90,000 above the existing loan (8.0%)

This strategy generates excellent passive income but adds complexity and risk. Each layer requires proper documentation, servicing, and disclosure.

Tax Implications

For the Seller (Wrap Note Holder)

• The wrap is treated as an installment sale under IRC Section 453
• Interest income from the spread is taxed as ordinary income
• Principal payments are split between return of basis (non-taxable) and capital gain
• The "unstated interest" rules may apply if the wrap rate is below the applicable federal rate (AFR)

For the Buyer

• Mortgage interest paid on the wrap may be deductible (primary residence or rental property)
• The buyer's basis in the property is the purchase price, regardless of the wrap structure
• Property tax deductions are unaffected by the financing structure

Frequently Asked Questions

What happens if the seller dies while the wrap is active?

The wraparound note becomes part of the seller's estate. The buyer continues making payments to the estate or the heir who inherits the note. The underlying mortgage must continue to be paid. This is why a third-party servicer is so important—they ensure continuity regardless of what happens to either party.

Can I get title insurance on a wraparound deal?

Yes, and you should. The title company will show the existing mortgage as an exception on the policy, but they'll insure your ownership interest. Some title companies are unfamiliar with wraps—find one that has experience with creative financing transactions.

What if I want to pay off the wrap early?

Review the prepayment terms in the promissory note. Some wraps have no [prepayment penalty](/blog/dscr-loan-prepayment-penalty). Others charge 1–3% of the remaining balance for early payoff. Negotiate prepayment terms before closing.

Is a wraparound mortgage the same as an AITD?

Yes. "All-Inclusive Trust Deed" (AITD) is the California term for a wraparound mortgage. They're the same instrument—a junior loan that includes the balance of the senior loan.

How do I foreclose on a wraparound mortgage if the buyer defaults?

You foreclose on the wraparound mortgage using your state's standard foreclosure process (judicial or non-judicial, depending on the state). While the foreclosure is proceeding, you must continue paying the underlying mortgage to prevent the first lienholder from also foreclosing.

Can a wraparound mortgage work on commercial property?

Absolutely. Commercial wraps are common in seller-financed business and commercial real estate transactions. The same principles apply: the wrap encompasses the existing financing, the buyer pays the seller, and the seller pays the underlying loan.

The Bottom Line

Wraparound mortgages are one of the most elegant tools in creative [real estate financing](/blog/balloon-mortgage-explained). They let sellers earn above-market returns on their equity while maintaining control over the underlying mortgage. They give buyers access to financing they couldn't get from a bank. And the interest rate spread creates genuine wealth for patient investors.

But wraps are complex instruments with real risks—due-on-sale acceleration, counterparty default, and legal compliance requirements that vary by state. Every wrap deal needs:

1. A real estate attorney who understands creative financing
2. A third-party loan servicer
3. Full disclosure to all parties
4. Proper documentation recorded with the county
5. An exit strategy for both sides

Get those five things right, and a wraparound mortgage can be one of the most profitable structures in your real estate toolkit.

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