What is a Wraparound Transaction in Texas?

A wraparound mortgage or wraparound transaction (sometimes referred to as a “subject to transaction”) is a special form of seller financing. The basic idea is that Bill wants to sell his real property to Jim. Jim cannot qualify for his own loan. Bill owes a mortgage to First Bank. Jim agrees to make payments to Bill (Second Lien or Wraparound Lien) and Bill will turn around and continue making his payment to First Bank. The two loans are now wrapped.

This is an alternative to the traditional property sale. It is often favored in situations where a buyer may not qualify for traditional financing. It is a type of sale that should only be used when there are no other choices. I like to call it “Plan C”.

            Plan A – Cash Buyer

            Plan B – Buyer that obtains financing from a traditional lender

            Plan C – Buyer that cannot qualify for a traditional loan

Is it Legal?

A wraparound transaction is a legal form of seller financing in Texas. Texas Property Code § 5.016 addresses the treatment of “Property Encumbered by an Existing Lien.” The statute provides the following points:

1. The statute does not invalidate a wraparound transaction (see Texas Property Code § 5.016(b));

2. The statute requires disclosure of the existing debt/lien before executing an earnest money contract;
3. If the all the statutory notices are not provided, then buyer has the right to terminate the earnest money contract; and
4. Once the transaction is executed, then the agreements are enforceable (subject to the Due on Sale Clause Risk).

My Realtor says that I cannot do a Wraparound Transaction:

Many realtors (real estate agent or real estate broker) tell their clients that a wraparound transaction is not legal. This is not true. Many brokers choose not to engage in wraparound transactions as a company policy; however, there are many real estate agents and brokers that will assist clients with selling a property with this type of financing. Please remember that the real estate broker is not an attorney and should not give legal advice. The broker’s primary job is to assist a Seller with marketing and getting a buyer. A wraparound transaction should only be attempted with an experienced real estate attorney.

Due on Sale Clause Risk:

Every typical mortgage includes a due on sale clause. This clause simply states that if the Borrower conveys (“Sale”) the Property without consent of the Lender, then the Lender can demand that the entire balance of the loan is “Due”. This is the primary risk involved in a wraparound transaction.

Texas Property Code § 5.016(a)(7) requires the following disclosure:

“WARNING: ONE OR MORE RECORDED LIENS HAVE BEEN FILED THAT MAKE A CLAIM AGAINST THIS PROPERTY AS LISTED BELOW. IF A LIEN IS NOT RELEASED AND THE PROPERTY IS CONVEYED WITHOUT THE CONSENT OF THE LIENHOLDER, IT IS POSSIBLE THE LIENHOLDER COULD DEMAND FULL PAYMENT OF THE OUTSTANDING BALANCE OF THE LIEN IMMEDIATELY. YOU MAY WISH TO CONTACT EACH LIENHOLDER FOR FURTHER INFORMATION AND DISCUSS THIS MATTER WITH AN ATTORNEY.”

The most frequent question is whether the First Lender will exercise its rights under the Due on Sale Clause. This issue should be carefully reviewed to address the risk and the parties should consider the following factors:

1. Is the first lien with a Traditional Big Lender, with an Individual, or with an Investor?

• Is the first lien a commercial loan or residential loan or line of credit loan?

• Does the first lien secure other Property (multiple collateral loan?

• Does the first lien have a Variable Interest Rate or Balloon Clause?

• I recommend that a Wraparound Transaction be short term financing only, no more than 3 to 5 years.

• How to handle the Home Owners Insurance on the Property. The First Lender will require that the Insurance Policy reflect the original Borrower.

• Be careful about the principal balance of the First Lien and the Wraparound Lien.

Can I get Title Insurance on a Wraparound Transaction?

Yes, the Wraparound Transaction does qualify for title insurance. Many title companies do not insure on a wraparound transaction; however, there are title companies that will insure. You and your attorney should review the indemnities required by the title company and be sure that you want title insurance.

Are there Other Alternatives to a Wraparound Transaction?

Some investors attempt to structure their transaction as a Contract for Deed or Lease with a Purchase or Lease with an Option Right (“Alternative Strategies”). These types of transaction are more of a Lease to Own arrangement and are highly regulated under Texas Law (see Texas Property Code § 5.062). It is nearly impossible to structure a wraparound under these “Alternative Strategies” and you may be subject to liability under the Texas Deceptive Trade Practices Act (see see Texas Property Code § 5.085).

Are there Other Mortgage Laws that Apply to Me?

If you are an investor or you are conducting more than one mortgage loan/wraparound transaction, then you will need to be familiar with the Texas Secure and Fair Enforcement for Mortgage Licensing Act of 2009 (the SAFE Act as implemented in Texas) and the federal Mortgage Reform and Anti-Predatory Lending Act (the Dodd-Frank law). Even though the SAFE Act and Dodd-Frank promulgate limits and conditions on owner finance, such transactions (including wraparounds transaction) continue to be legal.

Summary:

A wraparound transaction can be a positive experience for everyone involved if it is structured properly and everyone involved is educated about the process. A wraparound transaction is technical and should only be attempted with an experienced real estate attorney.