National Real Estate Exam (PSI)FinancingHard
A seller has an existing mortgage with a $150,000 balance at 5% interest. To finance the sale, the seller creates a wraparound mortgage for $200,000 at 7% interest, continuing to make payments on the original loan while collecting the buyer's payments on the full $200,000 balance. What is the primary financial benefit to the seller in this arrangement?
- AThe seller no longer owes payments on the underlying loan
- BThe seller profits from the interest rate spread between the wrapped loans
- CThe seller eliminates any risk from the due-on-sale clause
- DThe buyer automatically assumes the original 5% loan
Show answer & explanationAnswer & explanation
Correct answer: B. The seller profits from the interest rate spread between the wrapped loans
In a wraparound mortgage, the seller continues paying the lower-rate underlying loan (5%) while collecting payments from the buyer at the higher wraparound rate (7%), earning income on the interest rate spread over the wrapped portion. The seller remains personally liable for the original loan, and due-on-sale risk still exists if the underlying lender discovers the sale.
Why the other options are wrong
- A. The seller still must make payments on the original $150,000 loan.
- C. Wraparounds carry due-on-sale risk since the underlying loan is not paid off or disclosed.
- D. The buyer does not assume the original loan; the seller remains obligated on it.
Wraparound Mortgage
A junior financing arrangement where a new loan 'wraps around' an existing loan; the seller/lender collects payments on the full new balance while continuing to pay the underlying loan.
- Seller profits from the interest rate spread
- Underlying loan remains in the seller's name
- Risky if underlying loan has a due-on-sale clause
Memory trick: Wrap the old loan inside the new, pocket the interest spread.