Second mortgage seller financing is a way for a buyer without access to a traditional mortgage loan to buy a house. This type of financing may be called a wraparound loan or a carryback loan. If the seller's current mortgage contains a due-on-sale clause, the seller will need the mortgage lender's consent before the transaction can take place. The buyer and seller will need not only a mortgage document between them, but also a separate written agreement containing the terms of the relationship, signed by the buyer.
TL;DR (Too Long; Didn't Read)
A wraparound loan or a carryback loan will require the seller to finance the purchase and receive payments from the buyer, using them to pay the current mortgage. The seller will also receive a second mortgage on the property. The parties must execute a clear and detailed promissory note outlining the terms of the sale. If the seller's current mortgage contains a due-on-sale clause, the seller's current mortgage lender must consent to the transaction.
Mortgages and Clear Title
"Clear title" in a real estate transaction simply means that the seller is conveying the property to the buyer free of all liens and encumbrances. That includes mortgages, tax liens and judgment liens. The parties will use a title company, which will make sure all encumbrances are identified, and the sale price will pay off all of them, giving the buyer the property with only the debt he bargained for.
So, if Sam wants to sell a house to Barb and pass good title to her, they will hire a title company to compile all the encumbrances on the property. The title company will also issue a title insurance policy, so that if something is missed, it will be covered. At closing, the proceeds from the sale will be distributed to all the lienholders, and Barb will own the house clear, except for her new mortgage.
Traditional Real Estate Financing
In a straightforward real estate purchase transaction, the buyer obtains a mortgage loan from a bank or other lender to buy the house. The new loan will pay off all the encumbrances found by the title company, including the seller's existing mortgage. The seller walks away from the sale with no further interest in the property.
Traditional real estate financing might not be available to every buyer, however. If the buyer's credit is too poor, or if he doesn't have enough credit, he might have a hard time finding a lender who will give him a mortgage. In that case, he might need to get creative, and if the seller is willing, second mortgage seller financing might be an option.
Second Mortgage Seller Financing Basics
A motivated seller might be able to sell her property by holding a mortgage for a buyer who can't get a traditional mortgage loan. These types of seller-sponsored second mortgages/deeds of trust are also called carryback loans or wraparound loans.
In a wraparound loan, the seller agrees to sell the property even though the buyer cannot get a mortgage. The seller will continue to make his own mortgage payments, and the buyer will pay the seller enough to cover not only the seller's mortgage payments, but also the remaining amount of the purchase price. The buyer will give the seller a second mortgage on the property behind the seller’s existing mortgage.
Second Mortgage Seller Financing Payments
With this type of financing, the seller will normally require the buyer to pay the loan in full after a certain number of years, unlike a regular mortgage lender, which allows payment over 15 to 30 years. Seller financing is risky for the seller, so she will want to get out of the arrangement as quickly as possible. So although the amount of the monthly payment will be determined by amortizing the balance over 15 to 30 years, the actual full balance will be due in a much shorter time, such as three to five years. At that point, the buyer will need to make a balloon payment for the remaining balance, either through a refinance or through the sale of the property yet again.
Seller's Mortgage Must Be Assumable
For a wraparound loan or carryback loan to proceed, the seller's current mortgage must be assumable. This means that the mortgage document allows the seller to sell the property without paying the mortgage in full, as long as the payments are being made, either by the seller or by the new buyer (who assumes the mortgage). Federal Housing Administration and Veterans Affairs loans are usually assumable, but conventional loans are usually not.
Most conventional mortgage loans contain due-on-sale clauses, which mean that if the owner transfers the house to someone else for money, the lender must be paid in full. Otherwise, the seller is in breach of the mortgage agreement.
A nonassumable, due-on-sale mortgage may still be part of a wraparound loan, but only if the mortgage lender consents to the transaction in writing.
Necessary Documents for Second Mortgage
For a seller to extend a wraparound loan to a buyer, the following will be required:
- A promissory note that details the repayment arrangement between the buyer and the seller, signed by the buyer.
- A mortgage in favor of the seller, signed by the buyer. The seller will need to record the mortgage in the county where the property is located.
- A deed transferring the property to the buyer. The seller signs the deed, and the buyer records it with the county (or the title company will do it, if one is in use).
Because these arrangements carry a high risk to the seller, she should retain an attorney to assist in preparing the documents and making sure the language in the promissory note is precise and all-encompassing.
Example of a Wraparound Loan
Barb wants to buy a house from Sam for $200,000. Barb has $20,000 to put down on the house, so she needs to borrow $180,000 to complete the purchase. Barb can’t get a mortgage loan because of her credit. Sam agrees to help Barb finance the property through a wraparound loan.
Sam’s current mortgage loan with ABC Bank has a balance of $130,000, so he is converting some of his equity into a mortgage with Barb. His loan has monthly payments of $800. His mortgage is an FHA loan, and it does not have a due-on-sale clause, so he can agree to the wraparound loan without breaking his contract with his lender.
They write a promissory note that shows Sam loaning Barb $180,000, to be paid monthly based on 5 percent interest amortized over 30 years, so her monthly payments are $966.28. The note also requires Barb to pay the balance in full at the end of five years, so she'll pay the $966.28 per month for 60 months and a balloon for the remaining balance. Sam collects Barb’s payments and uses them to continue paying $800 per month to ABC Bank while pocketing the rest. At the end of five years, Barb has paid $57,976.80 toward the purchase price, and the balance due to Sam is roughly $165,000.
Barb will need to get a new loan to pay the $165,000 to Sam. Sam and ABC Bank will release their mortgages, and Barb's new lender will record its own mortgage on the property.
- Nolo: Seller Financing: How It Works in Home Sales
- Lawyers.com: Pros and Cons of Seller Financing for the Home Seller
- California Land Title Association: Creative Financing: Carrying Back a Second? You Need a Lender's Title Policy
- Legal Match: Owner Carryback Mortgages
- David J. Willis Attorney: Wraparound Transactions in Texas
- Fortune Builders: Understanding the Wraparound Mortgage
- The Mortgage Professor: What Is a Wrap-Around Mortgage?
Rebecca K. McDowell is an attorney focusing on creditor and debtor law. She has a B.A. in English and a J.D.