The Magic Of The Wraparound Mortgage

In times like these, when the economic future is so uncertain, let’s take a moment to revisit a lending vehicle that most people aren’t thinking about at the moment, the “wrap.” I know, I know, you’re wondering how this debt vehicle would be used in a real estate market such as this. Well, why not take a look at the function and structure of this type of mortgage and come to your own conclusions. In times like these, when the economic future is so uncertain, let’s take a moment to revisit a lending vehicle that most people aren’t thinking about at the moment, the “wrap.” I know, I know, you’re wondering how this debt vehicle would be used in a real estate market such as this. Well, why not take a look at the function and structure of this type of mortgage and come to your own conclusions.

A wraparound mortgage (also known as an all-inclusive mortgage or trust deed, commonly called a “wrap”) is defined as “a mortgage that secures a debt and includes the balance due under an existing first mortgage.” This type of mortgage will "wrap around" the current debt and include any new funds advanced.

Under the terms of a wrap, the borrower makes one monthly payment, which includes the payment due on the first mortgage and the principal and interest due on the “new money” advanced. The wrap holder then makes the payment due on the existing first mortgage. By using this method, the borrower can’t default on the first mortgage. If the borrower fails to make a payment, the wrap holder can continue to pay the existing first mortgage debt to protect its interests, while pursuing a foreclosure on the wrap.

When we talk about making a mortgage that will be in second position to an existing first mortgage, it raises the question of risk. If the borrower defaults on the payment of the first mortgage, the second mortgagee (lender) may not know about it. Any unpaid monthly payments, late charges, penalties, property taxes, insurance and legal costs can add up quickly. If this leads to a foreclosure action, these costs are paid before the second mortgage receives anything. The second mortgage is at risk of being foreclosed out if the property doesn’t sell at auction for enough to cover both loans and all the costs. However, when using the wraparound mortgage the payment on the first mortgage is included in the monthly payment from the borrower. A default cannot happen on the first mortgage without the wrap holder’s knowledge. It is an excellent instrument to use for mitigating risk when in second position, and, it can generate returns to the wrap holder that are much higher than normal.

The way to achieve the higher returns when using a wrap mortgage when in a junior position is that the principal reduction (amortization) realized by making monthly payments on the existing first mortgage goes to the wrap holder, not the borrower. This can make a significant difference in the yield of the wrap holder’s new money advanced. For instance, the actual principal reduction of an original $1,000,000 first mortgage with a 25-year term at a 7% interest rate is $20,000 in the fifth year of the loan.

When the wrap on that first mortgage includes $500,000 of new money advanced by the Grace Fund at 15.5% interest, the yield to the Fund looks like the example below.



One- year principal reduction

(amortization) of 1st mortgage: $20,000

Interest -only payments

on new Money @ 15.5% rate: +77,500

Total annual earnings

to The Grace Fund: $97,500

Annualized yield on new money: 19.5%



The older the first mortgage, the greater the annual principal reduction and the higher the yield to the Grace Fund. The amortized portion will be received by the Grace Fund when the wrap loan matures, usually in 12 to 18 months.

Grace Realty Group and its affiliates prefer property sellers that are willing to provide financing that includes an amortizing first mortgage that can be wrapped. The increased yield passes to the Grace Fund, which is how annual earnings over 15% are easily and safely achieved for distribution to investors.