A Mortgage Wrap is an alternative Seller financing tool which allows a Buyer/Borrower to purchase a property without the existing mortgage being paid off. Rates, terms and down payment are agreed upon by the Buyer and Seller through negotiations. A real estate attorney drafts the promissory note, deed of trust, warranty deed and associated documents.
Mortgage Wrap (“Wrap”) FAQs
What is a Wrap?
A mortgage wrap is simply the seller financing of a property that does not pay off the
current mortgage lien on the property. The property is conveyed and the existing
mortgage lien stays in place with a second lien held by the seller.
Is a Wrap Illegal?
A Wrap is not illegal. Rather, a risk is created that the underlying lender can technically
call the note due under the “due on sale” provision in the deed of trust. However, failure
to follow a term of the deed of trust is not illegal.
What is a “Due on Sale” clause?
Most real estate loans will have a contract term in the loan documents in which the
borrower agrees to not convey the collateralized property without either issuing payment
in full for the amount due on the loan or obtaining authority from the lender to convey the
property.
Will the lender call the loan due?
Each buyer and seller in a Wrap transaction will have to reach their own conclusion as to
whether a lender, in the current economic environment, would call a note due and
foreclose, when payments continue to be issued and the property remains properly
insured.
Can a buyer receive the First Time Home Buyer Credit if purchasing via a Wrap?
Yes. As stated on the IRS.Gov website, “If the taxpayer obtains the “benefits and
burdens” of ownership of a residence in a seller financing arrangement, then the taxpayer
can claim the credit even though the seller retains legal title. Factors that indicate that a
taxpayer has the benefits and burdens of ownership include: 1. the right of possession, 2.
the right to obtain legal title upon full payment of the purchase price, 3. the right to
construct improvements, 4. the obligation to pay property taxes, 5. the risk of loss, 6. the
responsibility to insure the property and 7. the duty to maintain the property. (New
7/2/09) (http://www.irs.gov/newsroom/article/0,,id=206291,00.html)
What is the Annual Percentage Rate (APR) for a Wrap promissory note?
The parties can negotiate and agree upon any APR that is not illegal under the applicable
state and federal lending regulations.
What is the down payment in a Wrap transaction?
The parties can negotiate and agree upon any down payment amount. The parties will
need to provide sufficient funds to issue payments for real estate commissions, closing
costs and any down payment amount desired by the seller.
Who provides Home Owner’s Insurance for the property?
The seller needs to maintain insurance on the property. If the seller terminates the
insurance, the original lender will purchase insurance at a greatly higher price and pass this cost to the seller. Similarly, the buyer will want to maintain insurance on the
property to protect against catastrophic loss.
When does a Wrap loan end?
The Wrap loan will end either by its terms or when the property is sold or refinanced.
Upon the sale or refinance, the underlying/original mortgage is paid off and the
remaining dollars go to the Wrap lender.
Is title insurance required in a Wrap transaction?
Title insurance is not legally required in a Wrap transaction. The purchase and issuance
of title insurance is to be negotiated and agreed upon by the buyer and seller. If title
insurance is issued, any claims in relation to the underlying mortgage on the property are
excluded from coverage.
Who owns the property after a Wrap transaction?
The seller will execute a warranty deed conveying the property to the buyer. This
warranty deed is filed in the property records for the county in which the property resides.
The buyer is the legal owner of the property with the seller maintaining similar rights of
redemption as a traditional mortgage lender.
Who pays the taxes on the property after a Wrap transaction?
The buyer is legally responsible for all taxes once the warranty deed is filed indicating
the buyer is the legal owner of the property. The buyer also receives the tax advantage of
being able to write off interest payments on the loan. The property taxes can be paid via
a servicing company as in traditional mortgage lending (see further information below).
What happens if the buyer defaults on the Wrap loan?
If the buyer fails to issue payments under the terms of the Wrap promissory note, the
seller will need to pursue non-judicial foreclosure under the terms of the deed of trust and
the applicable foreclosure laws. The seller remains responsible for the existing mortgage
until it is paid off in full.
What if the original lender learns of the conveyance of the property?
The lender would have the right under the terms of the loan agreement to accelerate the
note and call the funds due for full payoff. At this point, the buyer would either need to
negotiate an assumption of the mortgage or get a new loan to pay off the original loan.
What is an “all-inclusive deed of trust”?
This is another name for a wrap around mortgage.
What is a “subject to” purchase?
This is a purchase by a buyer in which the seller is not to receive any future payments
from the purchase. The buyer conveys full payment (usually less than the equity in the
property) and the seller loan remains in place with the payments to be issued by the
buyer.
How is a Wrap different from a Lease/Purchase Option?
In a Wrap, the buyer is the legal owner of the property. In a Lease/Purchase Option, the
seller remains the owner until the buyer executes upon his option to purchase the
property. Additionally, in Texas, a Lease/Purchase Option longer than 180 days is
governed by Title 2, Chapter 5, Sub-Chapter D of the Texas Property Code and the seller
must comply with very strict and sometimes onerous terms.
What if the seller does not issue payment to the existing mortgage lender? / What if
the buyer does not issue a payment to the seller? / What if the buyer does not pay
taxes? / How does the seller calculate the payoff amount when the property is
refinanced?
All of these questions (and others) can be answered by utilizing a loan servicing company
in the same manner as conventional mortgages. A loan servicing company will issue late
notices, issue acceleration notices, escrow funds for taxes and insurance, issue payments
for property tax and insurance, receive payments from the buyer, issue payments to the
existing lender, etc. All of the functions of a traditional loan servicing company are
provided to seller financing/Wrap transaction sales.
What are the fees for a Wrap transaction?
The parties will need to provide sufficient funds to issue payments for real estate
commissions, closing costs and any down payment amount desired by the seller. The
legal fees including the lien search fees, recording fees, courier fees and attorney’s fees
are based on the amount of the transaction. These fees will range from $1,500.00 to
$2,500.00 depending on the size and complexity of the transaction.
What if there are insufficient funds to pay realtor fees?
If the realtors agree, the commissions can be paid monthly via the payments issued by the
buyer. The loan servicing company can issue the realtors’ funds along with the existing
mortgage payment, taxes, insurance, etc.
What happens after the Wrap transaction?
The buyer will need to prepare to refinance or sell the property before the Wrap
promissory note matures. If the note matures and the buyer is not in a position to
refinance or sell the property, the seller will have a right to redeem the property.
What if the buyer cannot refinance by the maturity date?
The buyer needs to ensure that the reason for not being able to obtain traditional
financing is resolved before the maturity date. If not, the seller may not allow an
extension and could foreclose on the property for not paying off the loan on or before the
maturity date.
FAQ courtesy of T. Alan Ceshker, Attorney at Law