Wraparounds

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.

A wraparound mortgage is best explained using an example.  A simplified example of a traditional real estate sale looks something like the following: Sam Seller wishes to sell his home which has an outstanding mortgage. Bill Buyer wishes to buy Sam Seller's home and applies for a loan from a bank or similar lending institution.   Once approved for his loan, Bill Buyer pays Sam Seller a down payment, Bill's bank pays off Sam's outstanding mortgage and pays Sam the remainder.   Sam's mortgage is completely paid off and Bill owns the home, subject to the new mortgage he obtained from the bank.

Conversely, a typical wrap around mortgage transaction looks like the following: Sam Seller wishes to sell his home and Bill Buyer wishes to buy.  Instead of applying for a loan from a bank, Bill simply pays Sam a down payment and gives Sam promissory note for the remainder of the purchase price.   Bill now owns the home, subject to his promissory note to Sam.  Sam's original mortgage is still outstanding on the property as well as Bill's new mortgage.  Every month Bill pays Sam on his promissory note and Sam pays his bank on his original mortgage.  Bill's debt has "wrapped around" Sam's original mortgage.

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.

Use of a wraparound mortgage comes with its share of disadvantages and risks.  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.

Wraparound mortgages, like most real estate transactions, are complex.  If you have any questions, use the form on this page to to contact us or call 361-288-1880.