A wraparound mortgage (also called a mortgage wrap) is a special form of seller financing that provides property sellers and buyers with an alternative to the traditional property sale. Wraparound mortgages are a legal form of seller financing in Texas and are often favored in situations where a buyer may not be able to obtain a favorable form of traditional financing from a bank or other lending institution.
This article will provide a basic overview of wraparound financing and the advantages and disadvantages of its use. When you are considering selling or buying real estate in Austin, Round Rock, Cedar Park, or Pflugerville using a wraparound mortgage, you should consult an Austin real estate lawyer to help guide you through how best to structure the transaction, prepare the proper documents you need, and make sure that the transaction is handled efficiently.
Wraparound Mortgage Basics
A wraparound mortgage is best explained using an example. A simplified example of a traditional real estate sale looks something like the following: Seller (“S”) wishes to sell their home, which has an outstanding mortgage. Buyer (“B”) wishes to buy S’s home and applies for a loan from a bank or similar lending institution. Once approved for their loan, B pays S a down payment, and B’s bank pays off S’s outstanding mortgage, paying S the remainder. S’s mortgage is completely paid off, and B owns the home – subject to the new mortgage he obtained from the bank.
In contrast, a typical wraparound mortgage transaction looks like the following: S wishes to sell his home and B wishes to buy. Instead of applying for a loan from a bank, B simply pays S a down payment and gives S a promissory note for the remainder of the purchase price. B now owns the home subject to his promissory note to S. S’s original mortgage is still outstanding on the property as well as B’s new mortgage. Every month B pays S on his promissory note and S pays his bank on his original mortgage. Therefore, B’s debt has “wrapped around” S’s original mortgage.
Advantages of Wraparound Mortgages
A wraparound mortgage provides various benefits to both the buyer and the seller.
- First, a wraparound mortgage transaction is typically quicker to close than a traditional real estate sale. The seller does not need to go through the process of applying for and receiving a loan from an outside institution prior to closing.
- Second, a wraparound mortgage allows a buyer who may not qualify for a traditional mortgage to obtain financing for the purchase.
- Finally, a wraparound mortgage allows the buyer and seller to negotiate the transaction on their own terms, since there is no new outside lender involved.
Disadvantages of Wraparound Mortgages
Use of a wraparound mortgage comes with its share of disadvantages and risks, as well. First is the inherent risk associated with having two mortgages on the property. This creates two potential sources of default and foreclosure. For example, the original owner may fail to make payments on the original mortgage, potentially leading to foreclosure and causing the buyer to lose his interest in the property – despite making his payments on the wraparound mortgage. Alternatively, the buyer may default on his wraparound mortgage, leaving the original owner unable to make payments on the original mortgage, again resulting in a foreclosure. This risk can be mitigated through careful drafting of the wraparound mortgage, such as including provisions that allow the buyer to make payments on the original mortgage should the original owner fail to pay.
The second issue with wraparound mortgages arises when the original mortgage contains a due on sale clause. Most deeds of trust in Texas contain such clauses. A due on sales clause allows the lender of the original mortgage to accelerate or call a note due when ownership of the property is transferred. This presents particular problems for wraparound mortgages, as the sale of the property through the wraparound mortgage will trigger the clause, allowing the original lender to call the note due. Importantly, a due on sale clause gives the lender the right to exercise this clause, but does not require it to do so. Typically, a bank will not exercise this right unless there is a default or other issue with the mortgage, but the risk still remains present in wraparound transactions.
Questions? Contact Sheehan Law, PLLC
Wraparound mortgages, like all real estate transactions, are complex. If you have any questions about wraparound mortgages in Texas or anything else regarding real estate law, please do not hesitate to contact us by phone at (512) 251-4553 for an initial consultation, or fill out the contact form on our contact page with your questions.