What is a wraparound mortgage?
A wraparound mortgage is a junior loan from the seller to the buyer, and its balance covers both the seller’s existing mortgage and the seller’s equity being financed. The original loan is never paid off or restructured. It stays in place, in the seller’s name. The buyer pays the seller on the wrap note, and the seller pays the original lender.
The buyer gets title at closing, and the seller records a deed of trust or mortgage that secures the wrap note. That lien is junior to the original loan. Since the old loan never gets paid off, a wrap only works if the underlying lender allows it or never calls the loan due.
How wraparound mortgage payments flow
Each month, money flows from the buyer to the seller and then from the seller to the original lender. The seller keeps the difference. Here’s what typically happens.
- At closing, the buyer pays a down payment and signs a wrap note for the rest of the price, secured by a deed of trust or mortgage on the property.
- The seller’s existing loan stays in place. The buyer does not assume it and the original lender is not a party to the wrap.
- Each month the buyer pays the wrap payment, ideally to a third-party servicer rather than to the seller directly.
- The servicer pays the underlying loan payment first and sends the rest to the seller.
- When the wrap note matures or the buyer refinances, the payoff clears the underlying loan and the seller keeps what is left.
Why sellers use a wrap: the interest spread
Sellers mainly use a wraparound mortgage to capture the spread between the low rate on their existing loan and the higher rate on the wrap note. The seller collects interest on the full wrap balance but pays interest only on the smaller underlying balance, so the return on the seller’s own equity beats the note rate.
A wrap can also help a sale close. A buyer who can’t get bank financing, or doesn’t want to give up a cheap existing loan, may pay a fair price to buy on terms. For the seller, that can mean a faster sale, monthly income and gain spread over time as an installment sale.
Worked example: a wrap on a $2 million apartment building
Say a seller agrees to sell a 5+ unit building for $2,000,000. The existing loan has a $1,000,000 balance at 4.0% with 20 years left, and the payment is $6,059.80 a month. The buyer puts $300,000 down and signs a $1,700,000 wrap note at 7.0%, amortized over 30 years with a balloon at year seven. The wrap payment is $11,310.14 a month.
After paying the underlying loan, the seller keeps $5,250.34 a month, or $63,004 a year. In year one the seller collects $118,453 of interest on the wrap and pays $39,393 of interest on the old loan, for $79,059 of net interest. On the $700,000 of equity the seller financed, that works out to about 11.3%, compared with the 7.0% note rate.
At the year-seven balloon, the buyer still owes $1,549,506 on the wrap, and the underlying loan is down to $736,203. When the buyer pays off the wrap, the seller clears the old loan and keeps $813,303. Over the seven years, the seller earns $554,332 of net interest.
| Item | Underlying loan | Wrap note | Seller’s spread |
|---|---|---|---|
| Starting balance | $1,000,000 | $1,700,000 | $700,000 seller equity |
| Interest rate | 4.0% | 7.0% | 3.0 points on the loan, more on equity |
| Monthly payment | $6,059.80 | $11,310.14 | $5,250.34 |
| Year-one interest | $39,393 | $118,453 | $79,059 net (about 11.3%) |
| Balance at year 7 | $736,203 | $1,549,506 | $813,303 to seller at payoff |
The due-on-sale clause problem
The biggest risk in a wraparound mortgage is the due-on-sale clause in the seller’s existing loan. Most mortgages give the lender the right to demand full payment if the property is sold or transferred without its consent, and federal law, 12 U.S.C. 1701j-3, lets lenders enforce those clauses.
The same law blocks enforcement for certain transfers of homes with fewer than five units, such as a transfer to a spouse or into a living trust. A sale to an unrelated buyer isn’t on that list. Commercial and agency multifamily loans on 5+ unit buildings generally restrict transfers too, so a wrap on an apartment building usually needs the lender’s written consent.
If a lender calls the loan, the seller has to pay it off or face foreclosure, and the buyer’s equity is at risk too. The safe route is to ask the lender for consent or a formal assumption before closing. If the lender says no, a full refinance or a different structure is usually the better answer.
Wraparound vs seller financing vs subject-to vs assumption
A wrap is one of four common ways to sell a property that still has a mortgage. The main differences are who stays liable on the old loan and whether the lender agrees.
| Structure | Old loan | Who pays the lender | Lender consent | Seller’s exposure |
|---|---|---|---|---|
| Wraparound mortgage | Stays in place, in seller’s name | Seller, from buyer’s wrap payments | Usually needed under due-on-sale | Liable on old loan and carries a junior note |
| Seller financing (free and clear) | None, or paid off at closing | Buyer pays seller | Not needed | Only the note risk |
| Subject-to | Stays in place, in seller’s name | Buyer pays the lender directly | Usually needed under due-on-sale | Liable on old loan, often no note |
| Loan assumption | Buyer takes over the loan | Buyer pays the lender | Lender approves the buyer | Released only if the lender agrees |
How a wraparound mortgage is taxed as an installment sale
For federal tax, a wraparound sale is usually reported as an installment sale under Section 453, so the seller pays tax on the gain as principal comes in. The open question has been how to treat the old loan inside the wrap, and the answer changes how much gain is taxed in year one.
Temporary Treasury Regulation 15a.453-1(b)(3)(ii) treats wrapped debt as if the buyer took the property subject to it, even though the seller stays liable. That shrinks the contract price, and if the old loan is more than the seller’s basis, the excess counts as a payment in the year of sale.
In Professional Equities, Inc. v. Commissioner, 89 T.C. 165 (1987), the Tax Court held that rule invalid as inconsistent with Section 453. It followed the older Stonecrest case: in a true wrap, the contract price is the full selling price, not reduced by the underlying loan, because the seller collects the whole price and keeps paying the old loan.
Back to the example. Say the seller’s adjusted basis is $800,000 and selling costs are $80,000. Gross profit is $1,120,000, so the gross profit percentage is 56%. The $300,000 down payment produces $168,000 of gain in the year of sale, plus 56% of any wrap principal collected that year. Under the regulation’s approach, the $1,000,000 loan would exceed the $880,000 of basis plus selling costs by $120,000, and the seller would report $420,000 of gain up front. Have your CPA confirm the treatment before you sign. Depreciation recapture rules still apply, as in any installment sale.
Risks for the seller and the buyer, and how to protect both
A wraparound mortgage ties the seller and buyer to the same loan without the lender’s involvement, so each side depends on the other to pay. If the buyer stops paying, the seller is still liable on the old loan. If the seller stops paying the lender, the buyer can lose the property. A few protections cover most of that risk.
- Use a third-party loan servicer that collects the wrap payment and pays the underlying lender first, with statements to both sides.
- Escrow the underlying payment, taxes and insurance so nothing depends on one party remembering to pay.
- Record the wrap deed of trust or mortgage and buy a lender’s title policy on the seller’s lien; the buyer gets an owner’s policy.
- Keep hazard insurance in force with the underlying lender and the wrap seller both named as mortgagee or loss payee.
- Give the buyer the right to cure a missed underlying payment and credit it against the wrap note.
- Match the wrap’s balloon date to, or before, the underlying loan’s maturity, and spell out how a lender acceleration will be handled.
Consumer rules for 1–4 unit homes vs business-purpose deals on 5+ units
Federal consumer lending rules come into play mainly when a wrap finances a home for a buyer’s personal use. Regulation Z covers consumer credit, meaning credit for personal, family or household purposes, and defines a dwelling as a residential structure with one to four units. A wrap to a buyer who will live in a 1–4 unit home can bring in Dodd-Frank rules on loan originators and ability to repay.
Regulation Z has narrow exclusions for seller financers. Under 12 CFR 1026.36(a)(4) and (a)(5), a seller who finances three properties or fewer in a 12-month period, or a person, estate or trust that finances only one, is not treated as a loan originator if the financing meets set terms. Those terms include no negative amortization and, for the three-property exclusion, full amortization and a good-faith ability-to-repay review.
States add their own rules. Texas, for example, adopted Finance Code chapter 159 for wrap mortgage loans on residential real estate, effective January 1, 2022. It requires the wrap lender to be licensed or registered to make residential mortgage loans unless an exemption applies, and to give a written disclosure at least seven days before the wrap agreement is signed.
A wrap on a 5+ unit apartment building to an investor is a business-purpose loan, and Regulation Z exempts credit extended mainly for business or commercial purposes. So apartment wraps are simpler on the consumer side, but the due-on-sale clause, state usury limits and good documentation still matter.
When a wrap makes sense for a 5+ unit apartment building
A wraparound mortgage makes the most sense on an apartment building when the existing loan has a low fixed rate, the lender has agreed to the transfer and the building’s NOI comfortably covers the wrap payment. Run DSCR on the wrap payment, not the old loan payment, because that’s what the buyer has to carry.
If the lender won’t consent, the cleaner choices are usually a lender-approved assumption plus a second-position seller note, or a sale where the old loan is paid off and the seller carries a first-position note. Our seller financing guide covers both, and the installment sale guide covers the tax side in detail. If you’re pairing the sale with a 1031 exchange, the wrap note is boot, so plan for it with your intermediary before closing.
Selling your building with seller-carry terms
Skyline Capital Investments buys apartment buildings with five or more units nationwide, and we can offer seller-carry terms, including structures that keep an existing loan in place when the lender approves. Every term, from the down payment and rate to the balloon date and servicing, goes into the letter of intent so you and your CPA can review it before you commit.
Send the address and unit count through the form on this page or call (469) 660-2977. We typically respond within 48 hours.
