The wrap-around contract or its equivalent, the ‘all-inclusive’ deed of trust, is used primarily for

one of three purposes:

1. Interest-rate spreads. The seller benefits when the interest rate on the junior REC is greater than

the rate on the wrapped obligation. By including the unpaid balance of the wrapped obligation

in the amount owed on his equity balance, the seller can earn a ‘spread’ represented by the

difference between the REC interest rate and the rate on the wrapped obligation’s balance.

2. Due-on-sale avoidance. The wrap-around contract is also used to avoid the necessity for the

buyer to assume an existing HUD-insured obligation. The parties hope that the mortgagee will

not discover that a sale has occurred, and exercise its rights under the due-on-sale clause

contained in the mortgage. This use (or abuse) of the wrap-around contract, while not a

criminal violation, does violate the due-on-sale provisions of the mortgage, and presents serious

planning and drafting problems for the parties.

3. Subdivisions. The seller typically buys a tract of land using some form of seller financing, then

subdivides the tract into smaller lots, and sells the lots on individual REC’s.

When contemplating use of the wrap-around technique, start with the checklist in chapter 3. Then

add these items:

1. Provide for payments on the senior obligation to be made by the escrow agent! This is essential

for the protection of the buyer. This requirement should be stated in the purchase agreement

wrapped obligation is the

2. Coordinate the payment amounts. The required monthly principal and interest payment on the

junior REC, less the seller’s share of escrow fees, must be at least as large as the required

monthly payments of principal, interest and buyer’s escrow fees on the wrapped obligation.

Otherwise it won’t be possible for the escrow agent to make the payments on the wrapped

obligation. Don’t even

the escrow agent. It almost never works. Anyway, most escrow agents either will not accept

this requirement, or will charge a prohibitive fee for the additional servicing requirement.

3. Coordinate the amortization periods. The junior REC must be structured to ensure that the

senior obligation will be retired before the junior REC is paid off. For example, if the senior

obligation will be paid off with 200 regularly scheduled payments, then the junior REC should

be structured to amortize in not less than 201 payments. There are some additional risks to

consider:

- The junior REC can have a shorter amortization period, provided the amounts required to

be disbursed to the senior obligation are increased to assure timely payoff. Before doing

this, however, be sure to check the senior obligation for any prepayment penalties or

prohibitions.

- If the wrapped obligation contains any balloon payment provisions, it would be advisable

to include matching balloon provisions in the junior REC, in order to provide sufficient

funds to the escrow agent to satisfy the senior balloon obligation. If this is not done, then

the buyer loses control of his own destiny, and must depend on the seller to make the

balloon payments when they become due.

- If the wrapped obligation contains an adjustable interest rate provision and/or variable

payments, then the monthly disbursements from the junior REC to the wrapped obligation

must be structured to retire the wrapped obligation within the amortization period of the

junior REC under the worst-case scenario.

4. Require that all prepayments of principal be applied to the wrapped obligation.

Even if you carefully planned step 3 above so that scheduled payments on the junior REC will

retire the senior obligation in the required number of payments, the buyer can ‘trash’ your

plans by making voluntary principal prepayments. If the prepayments are disbursed to the

seller, rather than to the senior obligation, then when the junior REC is finally paid off, there

may well be an unpaid balance remaining on the senior obligation. That could be catastrophic

if the seller has moved from the state, cannot be found, or simply doesn’t want to pay off the

balance! To prevent this from happening, the REC should contain an escrow instruction

requiring the escrow agent to disburse the appropriate monthly amount,

agreement addendum, to be sure it gets included in the REC. Check the senior obligation for

5. Determine how taxes and insurance premiums will be paid. Does the senior obligation require

that taxes and insurance premiums (T & I) be paid through its servicing agent? If so, then a

provision must be added to the junior REC requiring the buyer to make these additional

payments to the escrow agent, for further remittance to the senior obligation. See

this chapter.

It will also be necessary to include a provision requiring the seller to remit to buyer any refund received

from the mortgagee at payoff. See

mortgagee will not recognize the buyer’s entitlement to any refund from the T & I trust account. An

assignment of trust funds could be executed and placed in escrow, but many mortgage servicers cannot

be relied upon to abide by the assignment.

If taxes and insurance premiums are not required to be submitted through the senior servicing agent, then

it would be advisable to require the buyer to pay taxes and premiums monthly to the junior REC escrow

agent, who would then be responsible for paying these items as they become due. See

chapter.

If it is decided to require escrowing of taxes and insurance, a copy of the most recently paid tax

bill and a copy of the declarations page of the insurance policy

agent at the time the documents are first placed in escrow. If this is not done, the escrow agent

should and most likely will refuse to commence the service until the items are produced, or the

T & I servicing requirement is removed from the REC.

Paying T & I through the escrow agent is a good idea, for several reasons.

·

dollars per month for this service. However, some agents also charge a significant

disbursement fee when the taxes or insurance premiums are paid out, and they will deduct

that fee from the T & I impound balance. The fee is often not shown on the escrow agent’s

fee schedule. It would be a good idea to “shop” escrow agents for a disclosure of the

“outgoing” fee that will be charged, before selecting an escrow agent.

·

monthly payments, the buyer avoids the burden of large annual or semi-annual tax

payments. Also, because the escrow agent will be paying the insurance premium annually,

avoided.

·

insurance agent to confirm buyer’s performance of these obligations. It removes the

necessity for sending demand letters for proof of payment of taxes and/or insurance.

Sellers frequently neglect these tasks, with the result that the property taxes may become

6. Be sure the correct type of hazard insurance policy is in effect. The buyer can obtain a

homeowner policy, and name the seller and the mortgagee on the policy as loss payees. The

insurance company will send a copy of the new policy to the mortgagee, however, which will

alert the mortgagee to the sale and possibly result in an exercise of a due-on-sale clause. For

this reason, some parties have attempted to allow the seller’s existing policy to remain in effect,

and add a provision to the REC that the buyer must obtain separate insurance coverage, if

desired, to protect his interest in the property and the contents. The problem with this approach

is that the seller is no longer an ‘owner-occupant’, and his homeowner’s policy is no longer

appropriate for his risk category. A failure by the seller to disclose the change of ownership and

occupancy of the property could result in a denial of coverage by the insuror. The seller will

need to convert his policy to a landlord - type policy. The insurance company will send a copy

of the new policy or certificate to the lender, however, thereby defeating the entire purpose of

this little subterfuge. For additional discussion of this issue, see Chapter 6, Taxes and

Insurance.

the sale to the mortgagee, for fear of triggering a due-on-sale clause. This is a dangerous

game, besides raising some possible ethical issues. If the mortgage is HUD-insured, the wraparound

approach may be completely unnecessary. If the buyer is financially unable to meet

HUD’s creditworthiness-at-time-of-sale requirements, consider the alternative method for

establishing creditworthiness described in chapter 3.

The RANM standard form accommodates wrap-around transactions. The terms-of-payment clause

in paragraph 2 of the form need only state the purchase price, down payment and net balance owed

to the seller, and the terms for payment of that balance. If the wrapped obligation requires PITI

payments, then a separate clause should be added to paragraph 2 requiring the buyer to pay, or to

reimburse the seller for taxes and insurance premiums paid through the wrapped obligation.

Paragraphs 3(a) and 3(b) of the form should be amended to relieve the buyer of the obligation to

provide tax receipts and copies of the insurance policy and renewals to the seller.

the total sum of

acknowledged, and the balance of

payable as follows:

Same as above, except the T & I clause would be changed to read as follows:

The following lien(s) or obligation(s) is currently outstanding on the property:

Type of lien or Obligation Holder Loan Number Recording Data: Book & Page

Mortgage to ABC Mortgage Company F97-456782 04-07-97 Bk. 97-4 Pg.7052-7055

Document no. 97034829

The Buyer does not assume or agree to pay the above-described obligation. All payments of principal and interest due on such

obligation shall be remitted by the Escrow Agent to ABC Mortgage Company or its successor in interest out of the Seller’s

proceeds. If the payments due from Buyer are insufficient to satisfy the amounts due to be made on the above-described obligation,

Seller shall pay Escrow Agent such additional funds as are necessary to keep such obligation current. Upon payment of this

contract in full, Seller shall obtain a release of the premises from the lien of the obligation described above. Buyer shall pay all late

payment penalties on the above-described obligation resulting from late payments. Seller shall notify Escrow Agent of any changes

in the monthly payment as may be required by ABC Mortgage Company or its successor in interest.