Jeffrey Wade
A wraparound mortgage is a type of junior loan that wraps or includes the current note due on the property. The buyer makes mortgage payments directly to the seller, who continues to make payments on their original loan. The buyer's new loan wraps around the seller's existing loan on the property. This type of mortgage is rare due to its complex nature, and it carries risks for both buyers and sellers. Insuring a property purchased through a wraparound mortgage can be challenging as it involves a new policy naming the buyer as the insured, which may trigger the due-on-sale clause in the contract. One possible solution is to structure the transaction as a trust, with the seller as the beneficiary and the buyer as the trustee, allowing the buyer to obtain insurance in their name for the trust's benefit.
| Characteristics | Values |
|---|---|
| Complication | A new policy naming the buyer as the insured must be provided to the lender to verify the insurance is paid and in compliance with the existing mortgage. |
| Risk | The lender may notice the change in ownership and execute the "due-on-sale" clause of the contract. |
| Solution 1 | The previous owner remains on the insurance policy with an agreement to file a claim on behalf of the new owner if necessary. |
| Solution 2 | The seller grants the title to a trust with themselves as the beneficiary and the buyer as the trustee. The buyer holds the title in the name of the trust for the benefit of the grantor. The buyer is now able to have insurance issued in their name for the benefit of the trust. |
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What You'll Learn
Complications with the insurance company
Insuring a wrap-around mortgage can be a complicated process due to the unique nature of this financing arrangement. Here are some potential complications that may arise when dealing with insurance companies in the context of a wrap-around mortgage:
- Due-on-Sale Clause: One of the primary concerns is the potential invocation of the "due-on-sale clause" by the lender. When a property is sold through a wrap-around mortgage, the original lender may consider this a violation of the loan terms and trigger the due-on-sale clause, requiring immediate repayment of the loan. This can create complications with the insurance company, as they may perceive a change in ownership and decide to enforce the clause.
- Insurance Policy Naming: Another challenge arises when naming the insured on the insurance policy. Typically, the buyer should be named as the insured to comply with the existing mortgage terms. However, this can alert the lender to the change in ownership, potentially triggering the due-on-sale clause. Some individuals try to navigate this issue by keeping the previous owner on the insurance policy, but this can lead to problems if the previous owner needs to file a claim or is unavailable when a claim needs to be made.
- Garn–St. Germain Depository Institutions Act of 1982: This congressional act provides certain conditions under which the due-on-sale clause cannot be applied. One such condition is when the property ownership is transferred into a living will, and the beneficiary is the original owner. This strategy can be complex and may not be applicable or desirable in all situations.
- Double Insurance Coverage: There is often confusion about whether both the seller and the buyer need separate insurance coverage for the property. Some suggest that double coverage is unnecessary and could lead to complications if a claim needs to be made, with potential finger-pointing between the parties involved.
- Lender Notification: When the buyer obtains insurance in their name, there is a risk that the lender will become aware of the change in ownership. This could trigger the due-on-sale clause and create complications with the insurance company.
To mitigate these potential complications, it is essential to seek legal advice and carefully structure the transaction. Working with an experienced real estate attorney can help navigate the complexities of insuring a wrap-around mortgage and ensure compliance with relevant laws and regulations.
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The 'due on sale' clause
The due-on-sale clause is a provision in a mortgage contract that gives the lender the right to demand repayment of the remaining balance of the loan when the property is sold or transferred to another party. It is a contractual right, not a law, meaning the lender may choose to enforce it or not. The clause is designed to protect the lender, ensuring they can require the borrower to repay them in full if the property is sold.
In the context of a wrap-around mortgage, the due-on-sale clause can be a potential pitfall. The seller must ensure their original mortgage permits a wrap-around arrangement, as some lenders may invoke the due-on-sale clause, requiring immediate repayment of the loan upon the transfer of the property. This is because the lender notices the change in ownership and executes the due-on-sale clause.
To get around this, some people attempt to keep the previous owner on the insurance policy, with an agreement that they will file a claim on behalf of the new owner if necessary. However, this approach has risks, such as the previous owner refusing to file a claim or being unable to be located.
A more structured approach involves the seller granting the title to a trust, with themselves as the beneficiary and the buyer as the trustee. The buyer then holds the title in the name of the trust for the benefit of the grantor (seller). The buyer can now have insurance issued in their name for the benefit of the trust. The lender is unaware of the change in ownership and the seller can then assign their beneficiary interest to the buyer. The buyer now effectively owns the property and can continuously pay the insurance premium, providing proof to the lender.
It is important to note that the practice of hiding a transfer from the lender is a grey area. While there have been no reported cases of criminal prosecution, it is unclear whether this is a perfectly legal transaction or if those involved are breaking the law.
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Keeping the previous owner on the insurance policy
When a property is purchased with a wrap-around mortgage, the buyer makes mortgage payments directly to the seller, who continues to pay off their original loan. This means that the seller maintains their existing mortgage while the buyer's mortgage "wraps" around the existing amount owed. In this scenario, the seller is still the legal owner of the property, and the lender may not be aware of the change in ownership.
To keep the previous owner on the insurance policy, the buyer can deed the property back to the seller and simultaneously deed it back to themselves, showing both deeds to the lender. This approach has been successfully used on several occasions. Additionally, the seller can grant the title to a trust with themselves as the beneficiary and the buyer as the trustee. As the trustee, the buyer holds the title in the name of the trust for the benefit of the grantor (seller). In this arrangement, the buyer can have insurance issued in their name for the benefit of the trust, and the lender remains unaware of the change in ownership.
However, it is important to note that this approach has several potential pitfalls. Firstly, it is a grey area if an insurance company is asked to pay a claim for a property no longer owned by the insured (previous owner). Secondly, there is a risk that the previous owner cannot be found or refuses to file a claim when needed. There is also the possibility that the previous owner files the claim and keeps the money for themselves.
Therefore, while keeping the previous owner on the insurance policy can be achieved through certain structures, it is generally not recommended due to the associated risks and complications. It is always advisable to seek expert advice in this area before making any insurance decisions.
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The Garn–St. Germain Depository Institutions Act of 1982
A wraparound mortgage is a home loan that allows the seller to maintain their existing mortgage while the buyer's mortgage "wraps" around the existing amount owed. Instead of paying a bank or lender, the buyer makes monthly payments directly to the seller. Wraparound mortgages are intended mainly for sellers looking to finance buyers who may struggle to secure traditional loans.
Insuring a property purchased with a wraparound mortgage can be challenging. One possible solution is based on the Garn–St. Germain Depository Institutions Act of 1982, which enabled the widespread use of the due-on-sale clause. This clause allows lenders to foreclose on a current loan when the property is transferred to another owner.
The Garn–St. Germain Depository Institutions Act was enacted by Congress in 1982 and signed by President Ronald Reagan on October 15, 1982. The primary purpose was to ease the pressure on banks and savings and loan associations, which had been restricted from raising their deposit interest rates. The act deregulated these institutions and allowed them to provide adjustable-rate mortgage loans. It also allowed consumers to place their mortgaged real estate in inter-vivos trusts without triggering the due-on-sale clause, making it easier to pass property to minors, heirs, or to protect assets from creditors or lawsuits.
While the Garn–St. Germain Depository Institutions Act provided benefits to consumers and lenders, it is disputed whether it contributed to the savings and loan crisis of the 1980s and 1990s.
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Structuring the deal as a trust
A wraparound mortgage is a type of junior loan that wraps or includes the current note due on the property. It is a form of secondary financing that offers flexible financing options. The buyer makes mortgage payments directly to the seller, who continues to make payments on their original loan. The new mortgage "wraps around" the existing one, encompassing both the remaining balance and the additional funds borrowed.
This structure allows the seller to maintain their existing mortgage while the buyer's mortgage wraps around the existing amount owed. The seller offers seller financing to help the buyer complete the purchase, and the buyer makes monthly payments directly to the seller. The seller then uses a portion of these payments to continue making their mortgage payments, pocketing the difference.
By structuring the deal as a trust, the risks associated with wraparound mortgages can be mitigated. The seller can ensure that they will be repaid, and the buyer can obtain financing for the purchase of the property. It is important to note that both parties should consider working with an experienced real estate attorney to guide them through the process and reduce their risk.
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Frequently asked questions
A wraparound mortgage is a type of junior loan that wraps or includes the current note due on the property. The buyer makes monthly payments to the seller, who, in turn, pays their mortgage lender.
Wraparound mortgages can be complicated to set up, and they carry risks for both buyers and sellers. If the buyer fails to make payments, the seller is still responsible for the original mortgage, potentially leading to foreclosure.
Buyers can explore several loan alternatives, including FHA loans, VA loans, and USDA loans.
Insuring a property purchased through a wraparound mortgage can be challenging. One option is to structure it so that the seller grants the title to a trust with themselves as the beneficiary and the buyer as the trustee. The buyer can then have insurance issued in their name for the benefit of the trust.
The biggest obstacle is the risk that the lender notices the change in ownership and executes the "due on sale" clause of the contract, which could require immediate repayment of the loan.
