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A wraparound transaction or a "wrap" is a form of creative seller-financing that leaves the original loan and lien in place when a property is sold. The buyer usually makes a down payment, gets a warranty deed (title), and signs a new note to the seller (the "wraparound note") for the balance of the sales price. This wraparound note, secured by a new deed of trust (the "wraparound deed of trust"), becomes a junior lien on the property behind the existing first lien. The buyer makes monthly payments to the seller on the wraparound note and the seller in turn makes payments to the first-lien lender. The original lender's note is referred to as the "wrapped note" and it remains secured by the "wrapped deed of trust." Note that is possible to wrap more than one prior note (e.g., an "80/20").

Often the principal of the wraparound note to the seller exceeds the amount of the payoff on the wrapped note – this is the seller´s profit. Alternatively, the buyer may make a cash payment to the seller for the seller´s equity, and the wraparound note payment will then be structured to correspond closely to the amount of the payment on the wrapped note (occasionally referred to as a "mirror wrap").

Specific wrap terms can vary from transaction to transaction, but the wraparound principle remains the same. Wrap paperwork begins with the earnest money contract which, in the case of the TREC 1-4 Family Contract, should include an addendum setting forth the terms of the wrap. A suggested form of the addendum is attached this article. At closing, details of the wrap should be contained in a comprehensive wraparound agreement.

Alternatively, if the parties are clear on terms and ready to move forward now, they can skip the contract phase and request that the attorney prepare wrap documents for immediate signature.

If and when the buyer gets a refinance loan, the wrapped loan is paid and released, and the seller keeps any cash that exceeds the payoff amount of this first lien. The main difference between a wrap and a conventional sale is that the seller must wait until the wraparound note matures or is paid in order to receive the full sales proceeds.

Wraparound financing is sometimes referred to as subordinate lien financing.

Wraparound documents should include (at minimum) the following:

The interest rate on the wrap note is often higher than that on the wrapped note, since seller financing usually carries a rate that is slightly higher than market. The wrap note is usually amortized over 15 or 30 years. In the past, wrap notes often ballooned in 3 to 7 years (i.e., the buyer had that 3 to 7 year period in which to refinance and pay off the wrap note); however, the Dodd-Frank law now prohibits such balloons in owner-financed transactions.

Wraps are a form of seller financing. Seller financing, always popular in Texas, is a legitimate and effective way to sell real estate in an economy where conventional financing may be scarce.

Residential lease-options exceeding 6 months (formerly the favorite of investors) and contracts for deed were both restricted by changes to the Texas Property Code made in 2005. Because these Code changes impose severe penalties on sellers if strict, burdensome rules are not followed, liability-averse sellers have moved away from lease-options and contracts for deed. Thus only a few types of residential owner financing remain practicable:

Those interested in traditional owner finance or land trusts should read the articles on these subjects at LoneStarLandLaw.com.

A wraparound is an "executed" (complete) transaction as opposed to an "executory" (incomplete or unfinished) transaction. The buyer gets a deed (title) to the property at closing – not at some future time. His indebtedness to the seller is evidenced by the wraparound note and is secured by the wraparound deed of trust. Therefore, the executory contract rules contained in Texas Property Code Sec. 5.061 et seq. do not apply. In the event of default by the buyer, the seller must foreclose in order to get the property back. This is usually not an undue hardship since Texas has one of the fastest non-judicial foreclosure statutes in the country (41 day minimum).

Some wraparound arrangements provide that the deed to the buyer will be held "in escrow" (often by a lawyer) as "security" for a period of time – for example until the buyer pays in the full down payment. The wrap paperwork usually states that the buyer is only leasing until the deed is delivered out of escrow. This is a bad idea. A material item of the transaction – the most material item, in fact, the warranty deed – is undelivered. Since the deal is unfinished, it qualifies as an executory contract and is therefore subject to the requirements and severe penalties of Prop. Code Sec. 5.061 et seq. Incidentally, this statute has a nasty "tie in" provision that makes violations of Sec. 5.061 also violations of the Deceptive Trade Practices – Consumer Protection Act (DTPA).

The practice outlined in the preceding paragraph is different from the "security deed" technique. A security deed is a deed back from the buyer to the seller that is intended to be filed by the seller only if the buyer defaults – i.e., in lieu of going through the foreclosure process. This firm will supply a security deed as part of the wrap doc package but makes no guarantees that a court will approve of this avoidance of foreclosure procedures if the security deed is challenged by the buyer.

Remember, real estate investors are not the most beloved of persons in a courtroom. The common perception is that investors are predators exploiting the unfortunate. Juries are often happy to award treble damages and attorney´s fees against investors, so caution is in order.

No. In an assumption, the buyer formally assumes the legal responsibility for paying the existing first-lien note. Sometimes this is done with the approval of the seller's lender and by paying an assumption fee; sometimes the promise to assume the existing debt is made directly (and only) to the seller by means of an assumption deed. Either way, it is expressly stated that the buyer is taking on the legal obligation of paying the first-lien note. This is not the case in a wrap transaction, which is a form of "subject to" transaction. The first-lien note remains the exclusive responsibility of the seller.

In a wrap, therefore, the first-lien note and the deed of trust securing it remain undisturbed. A new wrap note secured by a new wrap deed of trust is created. In other words, there are two separate and independent sets of payment obligations – the seller remains obligated on the first-lien note (which is "wrapped") until it is paid and released; and the buyer becomes obligated to the seller on a new wrap note and deed of trust. These obligations coexist.

Wrap transactions are legitimate – primarily because there is nothing that says they are not. There are numerous Texas cases in which wraparound transactions have been upheld. Even the State Bar of Texas, in its Real Estate Manual, publishes suggested forms for wrap documents, although this office does not recommend use of these forms because of their very elementary nature.

People occasionally worry that a wrap transaction will cause the first-lien lender to accelerate the existing note pursuant to the "due-on-sale" clause contained in the wrapped deed of trust. More on that below.

There are new laws affecting all forms of owner-financed transactions. These laws are the Texas Secure and Fair Enforcement for Mortgage Licensing Act of 2009 (the S.A.F.E. Act or "T-S.A.F.E." as implemented in Texas) and the federal Mortgage Reform and Anti-Predatory Lending Act (the Dodd-Frank law). The S.A.F.E. Act and Dodd-Frank impose certain limits and conditions on owner finance, but such owner-financed transactions (including wraps) continue to be legal.

The S.A.F.E. Act places a licensing requirement (a residential mortgage loan origination license or "RMLO") on certain types of owner financing extended by persons who are regularly engaged in selling owner-financed residences. Since wraparounds are a form of owner finance, the S.A.F.E. Act applies; however, the seller is required to be licensed only if the property is not the seller´s homestead and/or the sale is not to a family member. So, if the subject property is an investment rental house being sold to a non-family member, then the seller is required to have an RMLO license from the Texas Department of Savings and Mortgage Lending (TDSML). Obtaining the license requires training, a background check, and an exam. Note that the licensing rule applies only to residential wraps.

There is relief for sellers who are not in the business of regularly selling owner-financed residential properties. The Commissioner of the TDSML has ruled that the S.A.F.E. Act will not be applied to persons who make five or fewer owner-financed loans in a year, thus preserving the so-called "de minimus exemption" of Finance Code Sec. 156.202(a)(3).

Dodd-Frank overlaps the S.A.F.E Act in its regulatory intent and effect. It requires that a seller/lender in a residential owner-financed transaction (such as a wrap) determine at the time credit is extended that the buyer/borrower has the ability to repay the loan. The seller is obligated to investigate the buyer´s credit history, current and expected income, financial obligations, debt-to-income ratio, employment status, and the like in order to make this determination. Dodd-Frank provides for a de minimus exception for persons doing not more than three owner-financed transactions per year (so long as the seller/lender is not in the building business) – but (1) the loan must be fully amortizing (i.e., balloon notes are not permitted); (2) the seller must determine that the buyer has the ability to repay; and (3) the owner-financed note must have a fixed rate or, if adjustable, must adjust only after five or more years and be subject to reasonable annual and lifetime limitations on interest rate increases.

The intent of Dodd-Frank is essentially to put an end to the practice of making of loans to borrowers who cannot afford to pay them back.

It is not uncommon to wrap more than one note and lien (e.g., a first and second lien). The prior liens may even be to different lenders. The principle is the same – the buyer pays the seller on the wraparound note, and the seller then pays both prior notes. The lien securing the wraparound note is subordinate to both of the prior liens.

Consider the example of 123 Oak Street which has a market value of $100,000 but has been slow to move. There is a first lien in the amount of $50,000 to Apple Bank and a second lien in the amount of $25,000 to Orange Bank which, taken together, result in a $25,000 equity. In the usual case (conventional financing), a purchaser should be able to make a down payment and obtain third-party institutional financing so that the seller receives $25,000 at closing and goes merrily on his way. But what if the buyer is unable to get traditional financing? The solution is a seller-financed wrap note that may be in a premium amount – say $110,000 – which is subordinate to the notes due Apple and Orange Banks. As is customary with owner financing, the wrap note will bear a higher than market rate of interest. It is secured by a wrap deed of trust that enables the seller to conduct a traditional foreclosure if the buyer defaults on the wrap note.

Perhaps, but prudent investors will require the buyer/borrower to have a substantial down payment. The seller/lender should evaluate and approve the buyer´s qualifications just as any other lender would – in fact, Dodd-Frank requires this. The wraparound should be viewed as a legitimate device to sell property to reasonably qualified buyers who have money to put down and can afford the monthly payments. For less qualified buyers, a land trust may be the better option (see our article Land Trusts in Texas).

Yes. There may be circumstances where it may be a good idea to first transfer the property into a land trust and then do a wrap – but this is a more complicated version of the traditional wrap since a trust agreement will also have to be prepared.

No. Both residential and commercial wraps are possible. Commercial liens are more likely, however, to contain provisions that may expressly prohibit a wrap or any transfer without of title without prior lender consent. In all cases, but especially in commercial cases, one should carefully review the deed of trust securing the existing lien(s) before proceeding with a wrap.

The wrap seller can unload property at full market price – property which would otherwise have to be discounted or sit idly on the market. The seller gets at least some cash today (the buyer´s down payment) which either goes into the seller´s pocket or is used to reduce principal on the wrapped note (or a combination of both – this is negotiable). The seller is then out from under the payment burden, although the seller must continue to remain involved by forwarding payments to the first lienholder. The seller also gets the benefit of any spread between the interest rate on the wrapped note and wraparound note.

That is an easy question. The buyer does not have to apply and qualify for a new loan, at least not immediately. The buyer gets title to the property and immediate possession, without lengthy delays, expensive loan fees, and closing costs.

Aside from meeting objectives of the broker´s client, the buyer´s down payment supplies cash for the broker´s commission to be fully paid at closing, just as with any other transaction.

Yes, but availability is limited. Some title companies are more inclined to insure wraps than others. Certain underwriters are not comfortable with the wraparound process, for reasons of their own. It may be necessary to "shop" title companies until a wrap-friendly title company is found.

If a title company is issuing insurance, then closing will be held at the title company. However, most wraparounds are closed without title insurance, on the basis of an informal title search or a title report, in a lawyer´s office. After all, while title insurance is customary in Texas, it is not required.

Note that this office is not a "fee office" for a title company and does not offer title insurance. With all due respect to other attorneys who do this, we consider it a conflict of interest and confine ourselves to aggressively representing either the buyer or seller.

A wrap transaction is neither a breach of contract nor a "violation" of the due-on-sale clause. The due-on-sale clause merely gives the lender an option to take action if it chooses.

If you look carefully at the typical lender´s residential loan documents, you will see that there is no express prohibition against a transfer of property without the lender´s consent. Such documents generally state that if the borrower transfers the property without the lender´s permission then the lender may, if it so chooses, declare the loan due. Look at paragraph 18 of the Fannie Mae/Freddie Mac Uniform Deed of Trust:

This is not prohibitory language. It says the lender may accelerate the note if it wants to. When an investor transfers the property without consent from the lender, the investor makes it possible for the lender, if the lender so chooses, to accelerate; however, it is not a breach or violation of the deed of trust. It is not fraud. As attorney Bill Bronchick puts it, "There is no due-on-sale jail."

How often does a lender declare an otherwise performing loan due? Not often. The lender may not like the fact that the property has been sold to someone else and may even write a nasty letter about it, but – so long as payments continue on a timely basis – the risk that the lender will actually do anything about it is small. Note that this office issues no guarantees about what a lender will do in any particular situation, but we will tell you what the odds are.

Yes. Property Code Sec. 5.016 (effective January 1, 2008) requires that the seller (1) give 7 days notice to the buyer before closing that an existing loan is and will remain in place; (2) inform the buyer that buyer has this same 7 day period in which to rescind the earnest money contract without penalty; and also (3) provide a 7 day notice to the lender. These notices are all the obligation of the seller and must be in the form prescribed by the statute. Actual lender consent, however, is not required, which makes this a rather strange law. Lender notices, most often sent to the loan servicer, generally produce no response.

Note that the buyer´s opportunity to cancel is an exclusively pre-closing remedy. There is no right of recision after closing has occurred.

Prop. Code Sec. 5.016(c)10 provides an exception to the notice requirement when "the purchaser obtains a title insurance policy insuring the transfer of title to the real property." Thus if you are able to get a title company to insure your wrap, you can dispense with the 7 day notices.

This is a law that "has no teeth" to speak of. As a consequence, it is widely disregarded. For now, it has not had a significant restraining effect on owner-financed transactions.

This is an underwriting issue. In the case of a wrap, the seller is also the lender and (like any lender) should carefully consider the risks inherent in the transaction as well as the creditworthiness of the borrower before determining the amount of the down payment and what interest rate to charge. Dodd-Frank now requires this sort of seller due diligence. It is our view that any down payment less than 10% likely falls within the risky category.

Can part of the down payment be financed? Yes. There is no prohibition against it. Typically, the buyer would pay part of the down payment at closing and then promise to pay the balance within a short period – say 90 to 180 days – utilizing a second wrap note. Again, this is an underwriting issue for the seller, but it is a common enough practice.

The timing of payments is an issue, and it should be addressed in the wraparound agreement. It is a good idea to schedule payments on the wraparound note 7 to 10 days before payments are due on the wrapped note, so as to allow time for the seller to collect payments from the buyer and then forward them on to the wrapped lender in a timely manner.

Sellers in wrap transactions want to cancel their casualty insurance policy. This is inadvisable. The wrapped lender, who usually collects an escrow for taxes and insurance or at the very least is named as an additional insured, will be notified of the cancellation. The seller will then get a default letter from the wrapped lender who will "force place" another policy (usually much more expensive) at the seller´s expense. The existing policy should therefore be left in place and the buyer should obtain his own policy. This is an inherent imperfection in the wrap process.

What happens if there is a loss? Collecting on the seller´s insurance policy can be problematic after a wrap transaction since title to the property has changed hands. Even if the seller agrees to make a claim on behalf of the buyer, the insurer may refuse to pay it, asserting that the seller no longer owns it. Worse, this could potentially be construed as insurance fraud. Therefore the buyer should procure his own casualty and contents insurance and claims should be made pursuant to the buyer´s policy. It is unfortunate that this results in two policies being in place, but we are unaware of any reliable way around it.

If there is no escrow being collected by the wrapped lender, then it is in the seller´s best interest to collect one from the buyer.

Insurance issues should be thoroughly addressed in the wraparound agreement.

So long as the wraparound deed of trust permits it, a wrapped loan can be wrapped and wrapped again – although the documentation can become prolific. This permits an investor to purchase property on a wrap and then sell it the same way (at a higher price and interest rate, of course), collecting a down payment (the investor´s "front end" profit) from the new buyer in the process. Usually, this new buyer commits to go through credit repair with the goal (not the requirement) of paying off the wrap note early. The investor then gets his "back end" profit.

An additional, advanced trick: some investor/buyers include a "substitution of collateral" clause in their wraparound notes that allows the property to be freed from the wraparound lien so long as property of reasonably equivalent value is substituted in its place. If the buyer is an investor with multiple properties, this could be a useful option.

Let´s review: the seller receives a wrap deed of trust that enables the seller to foreclose if the buyer defaults in paying the wrap note. The seller can also seek and obtain a deficiency judgment if the sales price at foreclosure is insufficient to discharge the wrap note plus accrued interest and fees. Accordingly, the seller has the same ability to enforce the wrap note and lien as does any other lender – and in Texas, that is generally a swift process.

As mentioned above, Texas is fortunate to have an expedited non-judicial foreclosure process. Prop. Code Sec. 51.002 requires that a homeowner be given at least a 20 day notice of default and intent to accelerate the note if the default is not timely cured. If the deed of trust is on a FNMA form (unusual for a wrap) then a 30 day notice and opportunity to cure is required.

The default notice must be followed by a second letter stating that since the default was not cured, the note is accelerated and the property is being posted for foreclosure. This second notice must be given at least 21 days before the first Tuesday of the month in which the foreclosure will be held. So, a Texas foreclosure takes a minimum of 41 days – 51 days if a FNMA deed of trust is involved – although one should avoid cutting it that close when it comes to the notices. It is prudent to allow a "cushion."

There are two distinct advantages of the Texas foreclosure process: first, foreclosure cuts off any other subordinate liens that may be have been placed against the property while the buyer owned it (e.g., home improvement liens, mechanic´s liens, and the like); and second, there are no effective defenses to the foreclosure process except for the borrower to file a lawsuit and seek to block the sale with a temporary restraining order. For that, the buyer needs money and an attorney. Buyers in default usually have neither. Our companion article Foreclosure in Texas is suggested reading.

After foreclosure, the former buyer/owner may still refuse to leave, making an eviction ("forcible detainer" or "FED") necessary. In order to accomplish this, the owner must give a 3 day notice to vacate, file an FED petition in the Justice Court precinct where the property is located, get it served, get it heard by the Justice of the Peace, and then wait 5 days for the judgment to become final – at which time a writ of possession becomes available. The owner must pay for the writ and then wait until the constable posts a 48 hour notice on the door and – if necessary – forcibly removes occupants who are unwilling to leave. Elapsed time? At least 3 weeks, although an appeal to county court can lengthen this process significantly. For more details, see our article Evictions in Texas.

The wraparound agreement provides that if the seller fails to make payments to the wrapped lender the buyer may do so and receive credit against the wrapped note. The buyer should have the power (granted in the wraparound agreement) to occasionally request documentary proof from the seller that the wrapped note is current.

Two related situations are of interest: What happens if the seller (1) files bankruptcy and seeks the discharge of the wrapped debt; or (2) dies leaving the wrapped debt unpaid? In either case, the buyer could be forced to refinance the debt on short notice, which may be challenging. In the case of bankruptcy, the seller should agree in the wraparound agreement to execute a reaffirmation agreement on the wrapped debt (i.e., rather than seeking to discharge it in the bankruptcy). As for the premature death of the seller, the buyer should check to see if the seller has or can add term life protection (payoff insurance). If not, the buyer should consider protecting himself by obtaining a term life insurance policy on the seller in the amount of the balance on the wrapped debt.

The seller continues to be able to deduct interest paid on the wrapped loan. Nothing has changed there. As to interest on the wraparound note, interest received by the seller must be reported as income, and interest paid by the buyer is deductible. More details should be obtained from your tax advisor. Beyond these basics, this office does not give tax advice. Consult your CPA.

Obviously, the seller has to wait until the wraparound note matures in order to receive the full proceeds of the sale. Also, the wrapped loan is frozen in place and cannot be refinanced for the duration of the wrap. The seller has to collect and remit payments, which requires his or her ongoing involvement. If the wraparound borrower defaults, the seller must foreclose, which is not usually a problem with Texas´ expedited non-judicial foreclosure laws. In the unlikely event a loan is accelerated, the buyer may have to secure traditional financing (The wraparound agreement should specify the amount of time in which this must be done). The parties may also be carrying duplicate casualty insurance policies. Wraps are useful devices, but they are not perfect.

A properly drafted wraparound transaction will include a warranty deed, a wraparound deed of trust, a wrap note, and a wraparound agreement to address the details. These are sophisticated documents that are highly customized for the specific transaction. Only a qualified and experienced real estate attorney experienced in preparing wrap documents should be used to draft these papers. There are no "forms" available from any source, including the Texas State Bar, that are adequate to the task. Also, because there is no TREC or TAR standard wrap addendum, the TREC earnest money contract should include an attorney-prepared wrap addendum. A sample of such an addendum is attached to this article. Also attached is a client checklist that will provide the attorney with necessary basic information to begin drafting the wraparound documents.

Our office charges $750 for core residential wrap documents, $950 for commercial, not including recording fees which are usually about $90. A title report is not included.

1. The Wrapped Indebtedness is (check one):
   
   _________ paid current as of this date and is not otherwise in default. The next payment is due ________________________.
   
   _________ not current, as payments for the months of _______________________ have not been made. The loan is therefore behind in the approximate total amount of $ ____________ including late fees.
   
   
2. There are no other liens, encumbrances, or other indebtedness against or affecting the Property, whether recorded or not, other than the Wrapped Indebtedness. Seller also warrants that there are no IRS liens, ad valorem tax liens, mechanic’s liens, or HOA liens (actual, pending, or threatened) that have attached or may attach to the Property.
   
   
3. The Property has the following defects and/ or needs the following repairs: ____________________________________________________________________________________
   ____________________________________________________________________________________

For Houston:

For Dallas/Ft. Worth: