Wraparound Mortgages in Texas and The Pros and Cons of Seller Financing

What is a Wraparound Mortgage?

 A wraparound mortgage is a special type of seller financing where the seller creates a new loan for the buyer while retaining their existing mortgage. These loans typically carry a higher interest rate. Let’s look at an example:

A seller owns a property worth $200,000 and owes $100,000 on their existing mortgage to the bank. A buyer, who possibly can’t qualify for a new bank loan, wants to buy the property. Both parties agree a wraparound mortgage is the best option for the sale of the property. The buyer pays a downpayment of $20,000, the seller deeds the property to the buyer, and the buyer now carries back a new $180,000 mortgage on the property. The seller does not pay off their loan to the bank, but every month the buyer pays the seller the payment on the $180,000 note and the seller keeps making monthly mortgage payments. The new loan of $180,000 has “wrapped around” the initial $100,000 loan.

Legal Considerations With Seller Financing in a Wraparound Mortgage

Due on Sale Clauses

A main concern of a wraparound mortgage is the Due on Sale clause that is in most mortgage contracts. Due on Sale clauses allow the lender to demand full repayment if the property is sold without fulfilling the existing loan. The wording of a Due on Sale clause can vary, so if a wraparound mortgage is being considered the seller needs to examine it. Generally, the clause states that the lender “may” call the note due. In other words, the lender does not have to call the note, and implies that while it’s frowned upon, it’s not prohibited. However, considering most existing mortgages are through banks, it can be tough to have the bank approve a wraparound mortgage. Since this option is more likely to be used by those who have trouble securing traditional financing, the lender of the original mortgage may decline the wraparound mortgage for the same reason they decline traditional financing.

Regulatory Requirements

Since wraparound mortgages are a form of seller financing, they are subject to both federal and state versions of the Secure and Fair Enforcement for Mortgage Licensing Act of 2009 (“SAFE Act”), the Mortgage Reform and Anti-Predatory Lending Act (also known as “Dodd-Frank”), and in Texas, Texas Property Code §5.016, Conveyance of Residential Property Encumbered by Lien.

The SAFE Act requires the seller to be licensed as loan originators unless they qualify for an exemption. Some exemptions include:

• Homeowners selling their own property by offering financing to the buyer, as long as it’s no more than three loans to buyers
• Sellers assisting immediate family members (such as a child, parent, or sibling, by offering a mortgage loan
• Government workers who work for an agency or housing program (it’s the official job)
• Nonprofit organization workers who help people get affordable home loans with good terms
• Cities, counties, and organizations running housing programs (such as the Texas HOME program) can be exempt if the state finance commission approves it

If the seller is operating without proper licensing or exemption qualifications when they’re required to, it can result in hefty fines, invalidation of the loan, or legal action. 

The Dodd-Frank Act’s purpose is to establish rules to prevent risky or predatory lending practices. One rule is the seller must evaluate whether the buyer can afford the loan, which involves reviewing the buyer’s income, credit history, and debt obligations. In addition, there are some restrictions on the loan terms. Generally, balloon payments (large, one-time payments towards the end of the loan) are prohibited, and loans with excessively high interest rates or fees are heavily restricted. If the seller is non-compliant with the rules of this act, it can lead to fines or a rescission of the loan. 

In Texas, Texas Property Code §5.016 requires the seller to disclose the existence of any remaining liens on the property after the sale. The seller must disclose this in writing, and explain the risks associated with the lien such as a potential foreclosure if the original loan is not paid. The buyer then must acknowledge in writing before the sale is complete. If the seller does not comply with this Property Code, the transaction can be invalidated. 

Recent Legislative Updates

In January of 2022, Senate Bill 43 made changes to wraparound mortgages which effectively decrease the number of risks. SB 43 clarifies the licensing requirements for individuals who are looking to originate wrap loans, ensuring compliance with the SAFE Act standards. The bill also requires disclosure of information within a specific time frame (on or before the seventh day before the wraparound mortgage agreement is signed). This allows the buyer up to seven days to rescind the loan agreement. In the event the buyer receives the discloser after closing on the wraparound mortgage, they have up to twenty days to rescind the wrap agreement. Senate Bill 43 requires an attorney or title company to close a wrap mortgage loan. This ensures that SB 43 will be implemented properly. 

Simply, Senate Bill 43 aims to fix problems that let some people avoid following rules for registration or licenses:

• Closes Loopholes: Prevents people from avoiding registration or licensing requirements.
• Protects Borrower Payments: Ensures wrap payments are held in a trust for the benefit of borrowers.
• Requires Risk Disclosure: Lenders must clearly explain the nature and risks of wrap mortgage loans.
• Borrower Rights: Gives borrowers the right to cancel a wrap mortgage loan if proper disclosures are not made on time.

Notices Required for Wrap Sellers: A Comprehensive Guide

Understanding the notices required under Texas law for wraparound sellers is crucial for compliance and ensuring transparency with buyers. Key statutes from the Texas Property Code and Finance Code mandate specific disclosures to protect buyers, lenders, and other parties involved in wrap transactions. This guide details the essential notices and their requirements.

Property Code Section 5.016: Notices for Residential Property Encumbered by Liens

Texas Property Code Section 5.016 applies to the conveyance of residential property with an existing unpaid lien, making it directly relevant to wraparound transactions. This section requires sellers to provide buyers with a warning notice highlighting potential risks, such as the lienholder’s right to demand full payment if the lien is not released.

Required Warning Notice
The notice must include the following statement, in at least 12-point font:

“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.”

Timing and Buyer’s Rights:

• The seller must provide this notice at least seven days before closing.
• Buyers have a seven-day period to rescind the earnest money contract without penalty.
• The same notice must also be sent to the lienholder, although lender consent is not mandatory.

Notice Contents Must Include:

• Property identification.
• Contact information of each wrapped lienholder.
• Details of the secured debt, including amounts owed.
• Summary of loan terms (interest rate, monthly payments, and account numbers).
• Insurance policy information, including coverage amounts and insurer details.
• Property tax amounts.
• A statement indicating whether the lienholder has consented to the wraparound.

Exceptions to Property Code Section 5.016

Certain transactions are exempt from the notice requirement, such as:

• Transfers between co-owners or spouses.
• Situations where the buyer secures a title insurance policy at closing (Section 5.016(c)(10)).
• Transactions involving professional investors who have completed four or more real estate transactions in the preceding 12 months (Section 5.016(c)(11)).

Buyer’s Cancellation Remedy
If the seller fails to provide the required seven-day notice, the buyer has the right to cancel the transaction before closing. However, this remedy does not extend beyond closing.

Finance Code Section 159.101: Wrap Seller Disclosure on Insurance

Purpose of Disclosure
The Finance Code adds another layer of protection for buyers by requiring wrap sellers to disclose potential insurance coverage issues. Buyers must be warned that seller-maintained insurance may not cover them in case of loss or liability.

Required Warning Notice
The notice must include the following statement, in at least 12-point font:
“NOTICE REGARDING PROPERTY INSURANCE: ANY INSURANCE MAINTAINED BY A SELLER, LENDER, OR OTHER PERSON WHO IS NOT THE BUYER OF THIS PROPERTY MAY NOT PROVIDE COVERAGE TO THE BUYER IF THE BUYER SUFFERS A LOSS OR INCURS LIABILITY IN CONNECTION WITH THE PROPERTY. TO ENSURE THE BUYER’S INTERESTS ARE PROTECTED, THE BUYER SHOULD PURCHASE THE BUYER’S OWN PROPERTY INSURANCE. BEFORE PURCHASING THIS PROPERTY, YOU MAY WISH TO CONSULT AN INSURANCE AGENT REGARDING THE INSURANCE COVERAGE AVAILABLE TO YOU AS A BUYER OF THE PROPERTY.”

Timing and Format

• The disclosure must be provided at least seven days before the wrap mortgage loan agreement is entered into.
• The notice must be dated and signed by the buyer upon receipt.

Foreign Language Requirement
If negotiations were conducted primarily in a language other than English, the seller must provide the disclosure in that language to ensure the buyer fully understands the terms (Section 159.102).

Model Disclosure Forms and Compliance

The Texas Department of Savings and Mortgage Lending has developed a model disclosure form to assist wrap sellers in meeting these requirements. Sellers are encouraged to utilize this resource for accuracy and compliance.

Key Takeaways for Wrap Sellers

1. Understand Legal Obligations: Both the Property Code and Finance Code outline specific notices and disclosures required for wrap transactions. Non-compliance can lead to penalties or buyer rescission rights.
2. Provide Timely Notices: Ensure that buyers receive the required disclosures at least seven days before closing to allow time for review and rescission if necessary.
3. Document Buyer Acknowledgment: Maintain signed and dated copies of all disclosures to demonstrate compliance.
4. Verify Exemptions: Familiarize yourself with exceptions to the notice requirements to streamline transactions when applicable.

By adhering to these guidelines, wrap sellers can mitigate risks, enhance transparency, and ensure compliance with Texas law.

Benefits and Risks to Wraparound Mortgages and Seller Financing

There are benefits to a wraparound mortgage for both buyers and sellers. This type of seller financing allows the seller to earn interest on the loan by setting a higher interest rate than their current loan interest. This form of financing can also increase the buyer pool for the seller, since it includes individuals who are unable to secure traditional financing. For buyers who lack sufficient down payment funds, have poor credit, or struggle to qualify for traditional loans can still purchase a property through this method. The buyer also has more flexibility since the seller can offer more customized loan terms, making it a little bit easier to afford the property.

There are also risks to this type of seller financing. The Due on Sale clause is a big one because if the original lender enforces the clause, the seller can risk foreclosure if they are unable to pay off the balance. For the seller, if the buyer stops making payments, they are responsible for the original mortgage payments, and if they are unable to make those payments, it can result in foreclosure. For the buyer, if they find out that the seller hasn’t been making their payments on the original mortgage, they risk losing the property and/or foreclosure. Another risk to the buyer is the possibility of higher interest rates, which can increase the buyer’s overall costs and end up overpaying for the property. 

Understanding the Complexity of Wraparound Documentation

Why Are Wraparound Documents Complex?

Wraparound agreements, commonly referred to as wraps, are inherently complex transactions, made even more intricate by additional regulations introduced into the Texas Finance Code in 2022. Successfully navigating a wrap requires meticulous, professional-grade documentation beginning with the earnest money contract.

Using overly simplified documents—often produced by title companies—can lead to significant problems, such as:

• Key details being left to interpretation or assumption.
• Delays or failure to close the transaction.
• Potential legal disputes after the deal is finalized.

The Pitfalls of Simplistic Wraparound Documentation

Simplified documents might seem appealing for convenience, but they often omit critical components needed to protect both the buyer and seller. Wraparound transactions involve multiple layers of financial and legal obligations, leaving no room for ambiguity or shortcuts. A failure to address these complexities properly can jeopardize the transaction entirely.

Why Wraparound Documents Are Lengthy

Both buyers and sellers may find wraparound documentation lengthy and intricate, but this level of detail is essential. Here's why:

1. Legal and Financial Layers: Wraps involve multiple obligations, such as the first-lien note and the wraparound note, which require comprehensive coverage.
2. Regulatory Compliance: Recent Finance Code updates mandate stricter adherence to regulations, adding complexity to the documentation.
3. Risk Mitigation: Properly drafted documents reduce the risk of misunderstandings and future litigation.

Wraparound Mortgages and Seller Financing FAQS

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