By: Ben Auten, Esq. for Wolf, Rifkin, Shapiro, Schulman & Rabkin, LLP
With the continued steady increase in home prices for both Clark and Washoe counties, the resurgence of creative financing in order to facilitate closing on residential transactions is inevitable. In particular, a seller might hear the term, “wrap-around mortgage” when entertaining an otherwise attractive offer from a prospective buyer that is unable to pursue traditional lending options. A wrap-around mortgage is a loan transaction wherein the lender ultimately takes responsibility for an existing mortgage. Consider as an example, a seller that has a $100,000 loan on his or her home may decide to sell that home to a buyer for $150,000. The buyer pays a down payment, say $10,000, and in that context, buyer borrows the remaining $140,000 under a new loan from the lender. The new loan “wraps around” the existing $100,000 loan since it will become the responsibility of the new lender to stay current on the old loan by making timely payments. There are a financial reasons that can make the wrap-around structure appealing to a lender and generate legitimate interest in this form of financing.
Typically, but not in every circumstance, the lender in a wrap-around is also the residential home seller; in other words, the wrap-around is one form of seller-financing. In most wrap-around scenarios, buyer’s monthly loan payment is remitted directly to an independent third party, which subsequently submits the payment to the original lender. The underlying seller remains liable on the original loan, however, and is entirely dependent on the timely actions of that third party, i.e., the seller may not be made aware that a payment was late until he or she receives written notice from the original lender.
A “wrap-around mortgage” seems to be a truly viable option when a seller has a captive, interested buyer that cannot (or will not) secure traditional financing. That said, any seller that is also going to serve as lender in order to consummate the deal must be aware, the original lender likely included a due-on-sale clause in its loan documents, i.e., it would be rare for a lender not do so, which prohibits a home buyer from assuming a seller’s existing loan without the lender’s documented approval. A due-on-sale clause is a provision in loan documents that provides the full balance of the subject loan may be called due, i.e., repaid in full, upon sale or transfer of ownership of the home used to secure that loan. The original lender has the right, though it is not obligated, to call the loan due in such a case.
While a wrap-around structure may be utilized to sidestep a lender’s restriction on assuming an existing loan, it is nonetheless extremely likely that seller in doing so will have expressly violated its loan agreement with the original lender. Nevada law does not require escrow and title companies to notify the original lender that its loan is being “wrapped” in a pending sale transaction; but, nonetheless upon notice of any kind, the original lender may immediately call the underlying loan due and payable or it may alternatively demand an increase in the current interest rate for the loan as well as an assumption fee to be paid by seller. Before a seller agrees to sell his or her home and act as lender under a “wrap-around mortgage”, he or she must consider whether the risk involved, not just the benefit, to such an alternative structure, especially if the underlying loan is actually called immediately due and payable as a result at a later time.
About Ben Auten: Ben is an associate in the Las Vegas office of Wolf, Rifkin, Shapiro, Schulman & Rabkin, LLP, with a legal practice concentrating on transactional real estate, including, but not limited to, acquisitions and dispositions, development, financing, opinion letters, leasing, and related corporate and limited-liability company matters. Please contact him at our Las Vegas office if you have any questions about wrap-around mortgages. PH. 702-341-5200