While many choose a traditional mortgage when purchasing a home, other options are available in Texas to meet the varying needs of buyers. One option is a wraparound mortgage, which offers advantages for buyers and sellers, but which also has greater risks than traditional mortgage loans. To help decrease those risks, SB 43, effective since January 2022, implements key changes regarding wraparound mortgages.
Definition
A wraparound mortgage (also called a mortgage wrap) is a special form of seller financing which leaves an unreleased lien against the property after the sale. These mortgages are a legal form of seller-financing in Texas, popular in situations where a buyer may not be able to obtain traditional financing from a bank or other lending institution. The buyer and seller agree to terms of the mortgage loan, including the amounts of the down payment and the loan itself, at which point they sign a promissory note. The deed for the home is then passed to the buyer. The seller, now a wrap lender, no longer owns the home but continues paying the original mortgage with the payment from the new buyer, the wrap borrower. The wrap lender benefits from this arrangement because the interest rates are usually higher than they would be for a traditional loan. The wrap borrower benefits from the greater financial flexibility.
Previous Risks
While the wrap mortgage helps sellers who may have difficulty selling a home and buyers who may have difficulty qualifying for a loan, it also holds risks for both. Many mortgages contain a Due on Sale clause, which means that the original lender, usually a bank, may call the note due when a property conveys to a new owner. When the deed conveys to the buyer, it triggers the Due on Sale clause, usually giving the lender the option of calling the note due. The wrap lender remains responsible for paying the original mortgage, and if the wrap borrower does not make payments, the wrap lender remains responsible for making payments to the original financing institution, as the original contract indicates. In the event of borrower default, the wrap lender would be forced to foreclose on the property.
Wrap borrowers were also at greater risk than with a traditional loan. Until recently, the wrap borrower might pay what is owed when it is owed. However, if the wrap lender did not make payments on the original loan as promised, that loan could go into default. The bank then has the option to foreclose on the property. Thus, the wrap borrower has been at risk of losing the property despite having made payments as agreed. Many wrap borrowers are advised to receive a power of attorney from the wrap lender and make payments directly to the underlying lien holder to help alleviate this risk.
Recent Changes
Fortunately, SB 43 has made changes to wrap mortgages which substantially decrease some of these risks, effective January of 2022. The changes include classifying wrap mortgages as residential mortgage loans available only to those individuals who are registered to originate residential mortgage loans. These and other stipulations effectively prevent house flippers from taking advantage of wrap mortgages.
Another helpful change is that SB 43 protects the wrap seller by securing the wrap lender’s debt. In addition, it establishes that the wrap lender owes a fiduciary duty to the wrap borrower. It also requires the wrap lender to hold payments in a constructive trust for the buyer. The wrap lender is also protected by SB 43 because the bill obligates the borrower to pay the debt as agreed.
Another requirement of SB 43 is specific disclosure of information within a specific timeframe. Because a wrap mortgage conveys property that is encumbered by a lien, the original mortgage taken out by the wrap lender, SB 43 requires that the wrap lender must notify the wrap borrower of that encumbrance on or before the seventh day before the wrap mortgage agreement is signed. The wrap borrower then has up to seven days after receiving the lien disclosure to rescind the loan agreement. If the wrap borrower receives the disclosure after closing on the wrap mortgage, the wrap borrower has up to twenty-days to rescind the wrap agreements.
To help ensure that the lien disclosure is clearly communicated, the wrap lender must provide a disclosure written in the wrap borrower’s language. The Texas Department of Savings and Mortgage provides sample disclosure forms in both English and Spanish on its website. Texas Fin. Code § 159.101.
Lastly and most importantly, SB 43 requires that an attorney or title company must close a wrap mortgage loan. Working with a real estate attorney will first of all verify that a wrap mortgage is the best option for a client. It also ensures that SB 43 will be implemented properly, saving time, money, and distress in the process.
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