A wraparound mortgage is a form of seller financing in which the seller extends the buyer a new junior loan that wraps around the seller's existing senior mortgage. The buyer pays the seller on the full wrap balance, and the seller keeps paying the underlying senior loan, pocketing the interest spread between the two rates.
How a Wraparound Mortgage Works
A wraparound mortgage is structured as a single new note that layers on top of the seller's untouched first-lien loan. The buyer signs a promissory note for the full wrap amount, sends one monthly payment to the seller, and the seller continues servicing the senior debt from those funds. The senior mortgage stays in the seller's name and in first position.
The wrap note covers the seller's remaining purchase-money equity plus the outstanding senior balance. Because the buyer is paying interest on that entire amount, while the seller pays interest only on the smaller senior balance, the seller earns a spread on every dollar of the wrapped senior loan. Per the legal reference LegalMatch, the buyer makes payments to the seller, who is then responsible for paying the underlying mortgagee.
The rate arbitrage is the engine. The seller collects the wrap rate on the full balance and pays the lower senior rate on a portion of it. The wider the gap between the buyer's wrap rate and the seller's senior rate, and the larger the wrapped balance, the more the seller earns above the note's stated rate.
Why a Wraparound Mortgage Matters
A wraparound mortgage is a tool for closing a deal when a buyer cannot qualify for conventional financing or when an existing below-market loan is worth preserving. For the seller it converts a sale into an income stream that yields more than the note rate alone, because the spread on the wrapped senior balance lifts the effective return on the seller's actual equity.
For an operator underwriting a wrap, the structure matters because it keeps a low senior rate in place instead of refinancing it away. When the senior loan carries a rate well below current market, wrapping it can be worth more than the headline sale price. The trade is control: the seller stays personally liable on the senior note even after handing over possession.
Example
A wraparound mortgage earns the seller two layers of return: the note rate on genuine seller equity, plus the rate spread on the wrapped senior balance. Assume a $500,000 sale, a $50,000 down payment, and a $450,000 wrap note at 7.0 percent that wraps a $300,000 senior mortgage at 4.0 percent. The table below isolates the spread the seller earns on the underlying balance.
Component | Balance | Rate | Annual interest |
|---|---|---|---|
Wrap note (buyer pays seller) | $450,000 | 7.0% | $31,500 |
Senior mortgage (seller pays lender) | $300,000 | 4.0% | $12,000 |
Net interest to seller | $19,500 | ||
Spread on wrapped $300,000 balance | $300,000 | 3.0% | $9,000 |
The seller nets $19,500 a year on $150,000 of true carried equity, an effective yield of 13.0 percent, well above the 7.0 percent note rate. The extra 6.0 points come entirely from the $9,000 spread earned on the wrapped $300,000 senior balance.
Variations and Edge Cases
A wraparound mortgage is exposed to one dominant risk: the due-on-sale clause. Nearly every senior loan contains a due-on-sale clause that lets the lender demand full repayment when title transfers, and a wrap triggers that transfer. Per the Texas real estate firm Sheehan Law PLLC, lenders rarely invoke the clause unless the loan goes into default, but the right exists and the seller carries it.
Tax treatment is the second edge case. A properly documented wrap can be reported as an installment sale under IRS Publication 537, with gain recognized on Form 6252 as payments arrive. The IRS also requires seller-financed notes to charge at least the applicable federal rate; the short-term AFR was 3.63 percent in January 2026. A note priced below the AFR forces the IRS to impute interest, converting capital gain into ordinary income.
Wraparound Mortgage vs Second Mortgage
A wraparound mortgage is often confused with a second mortgage. A wraparound mortgage is a single junior note whose balance includes the senior loan, so the buyer makes one blended payment to the seller, who then services the senior debt. A second mortgage is a separate junior loan sitting behind the first, where the borrower pays two lenders directly and the balances never combine.
Feature | Wraparound mortgage | Second mortgage |
|---|---|---|
Number of payments buyer makes | One, to the seller | Two, to each lender |
Senior balance | Included in the wrap note | Kept fully separate |
Who services the senior loan | The seller | The borrower |
Rate spread earned | Yes, on the wrapped balance | No |
Frequently Asked Questions
Is a wraparound mortgage legal?
A wraparound mortgage is legal in most states when documented properly, but it carries due-on-sale risk. Because title transfers to the buyer while the senior loan stays in the seller's name, the senior lender may call the balance due, so both parties should use counsel and full disclosure.
Who holds title in a wraparound mortgage?
The buyer takes title to the property, and the seller retains a lien through the wraparound note. The seller keeps the underlying senior loan in their own name and remains personally liable to that lender even after the buyer takes possession.
How does the seller make money on a wraparound mortgage?
The seller earns the interest spread between the wrap rate charged to the buyer and the lower rate owed on the senior loan. On the wrapped senior balance the seller collects the difference between the two rates, lifting the effective yield above the note's stated rate.