When the commercial lending market climate is dry, buyers and sellers of commercial real estate start looking for creative financing solutions. One possible alternative is called a “wraparound” mortgage. While not without its risks, a wraparound mortgage can create mutually beneficial sales when no mortgage credit is available.
What is a Wraparound Commercial Mortgage?
A wraparound mortgage is when a seller provides financing to the buyer directly. The seller holds onto the original mortgage. The buyer makes a down payment to the seller on a new loan drawn up between them and then makes monthly payments to the seller. The seller then takes that money and makes payments on the original mortgage.
Example of Wraparound Commercial Mortgage
For example, a seller has a commercial property that she wants to sell. She still has a mortgage with a balance of $800,000 with an interest rate of 5 percent. A buyer wants to buy it but either cannot qualify for a commercial loan or does not want to. This could be because of a recent bankruptcy or because he already owns too many properties and cannot get any more financing. Whatever the reason, the buyer has the income to make payments. If the seller feels this is the best buyer, she makes a loan to the buyer and the deed is signed over to the buyer and recorded on land records. The loan might be something like $1,100,000 million at 6 percent with a $250,000 down payment. The seller gets to pocket all that cash and earn money on the higher interest rate while continuing to make her original payments on the $800,000 loan. The buyer benefits by not having to pay all the lender fees and not having to go through the hoops of qualifying for commercial mortgage funding.
If all the conditions are right, this can be a great deal for both parties. However, there are significant risks to both parties.
Risks of Wraparound Commercial Mortgages
If the seller stops making payments on the original mortgage, the buyer may lose the commercial property to foreclosure even though he has been making his payments to the seller. And the seller faces similar consequences if the buyer defaults on his loan commitments. There are legal ways to minimize these risks. A professional mortgage lawyer can help in these situations.
When traditional financing does not seem to be an option, wraparound mortgages can sometimes be the right answer.