Understanding wrap mortgages before entering into a real estate transaction will help you avoid legal problems. Wrap mortgages are valuable when buyers want to "assume" the current mortgage and sellers are having trouble selling their properties. Without a deed transfer, though, the transaction becomes quite risky for both parties. Check your state regulations as it is unlawful to use wrap mortgages in some locations. Be careful if the seller resists transferring the deed.
How It Works
A wrap around mortgage, commonly called a wrap, is basically seller financing for a specified period. The current bank mortgage is not paid off at the "time" of the sale, but the deed is transferred to the buyer. If both parties choose not to transfer ownership, a wrap is seldom used. In its place, you'll typically use an Installment Land Contract or a Lease/Option to Buy agreement. Wraps can create serious problems if the current mortgage includes a "due-on-sale" clause, as most home loans do.
Homeowners often have mortgages with a due-on-sale clauses. This means that when you sell or transfer ownership, your mortgage loan must be paid off. For example, if you sell your home four years after you buy it, your 30-year mortgage is due and payable in full. Should you agree to a wrap with your buyer, you cannot make your mortgage lender aware of this transaction. If the lender learns of it, you still might be required to pay off the loan, as the due-on-sale clause will kick in.
When there is no deed transfer, the buyer assumes some serious risks. Even in states that permit wraps, a deed transfer is appropriate. Without title to the property, the buyer risks having the seller incur (tax) or place (second mortgage) additional liens on what should be your property. Therefore, the buyer's deposit paid and future ownership, even in a best case situation, will be in jeopardy. A second serious risk is that the seller stops paying the mortgage while the buyer continues to send the agreed-to monthly payment, which covers the loan requirement. The wrap mortgage might be legal, but the buyer stands to lose large sums of money or, possibly, the home.
Sellers face some risks with or without deed transfers. Some state laws give buyers an "equity interest" with ILCs or Lease/Options after they've made some payments. There are also states that mandate notification of a "property transfer" with wraps, ILCs and Lease/Options. In other states, the buyer may "void" the contract or wrap, with the seller required to return all payments made, including interest. A legal wrap accompanied with a deed transfer includes the risk of buyer nonpayment. However, the seller can then foreclose on the wrap mortgage to recover ownership of the real estate.
In many states a wrap is legal and is not deemed a violation of a due-on-sale clause. The current mortgage lender, though, may decide to call the loan if a borrower transfers the property without the lender's consent. A wrap acts like an assumption, but it is not. There is no agreement between buyer and lender to permit the buyer to assume (become the borrower of) the mortgage. The buyer, though, is legally obligated to the seller, who, in turn, remains legally obligated to the mortgage lender. While the wrap is legal, the potential problems from this complex relationship are many.