The last period of high inflation in California mortgage loan rates this author saw the use of all-inclusive deeds of trust (a.k.a. wraparound deed of trust) to allow borrowers to acquire property when it was difficult to qualify for a high interest rate loan for the entire purchase price. Given the amount of money dumped into the economy by the federal reserve, inflation is likely to be returning, and buyers & sellers will again be using this type of creative financing.
An all-inclusive deed of trust (“AITD”) is used when the seller will be financing part of the selling price, and the buyer will also take subject to the existing deed of trust. The seller remains on the existing loan (and continues to make the payments) and finances the difference between the existing loan balance and the purchase price.
There are two situations in which all-inclusive deeds of trust are used:
1. When the interest rate on the existing loan is much lower then the current prevailing rate, the rate of the wraparound can be lower then the [prevailing rate, and the seller still earns a spread between the rate he is paying and the rate that the buyer is paying to the seller; and
2. When the interest rate on the existing loan is substantially higher than the current rate, the buyer is able to ‘buy-down’ the high rate by paying a rate closer to the prevailing rate. This situation may be less lucrative for the seller, as he still must pay the higher rate on the existing loan.
In either case the wrap around can used when the underlying loan cannot be prepaid without substantial penalty, or when the buyer does not qualify for a loan for the entire purchase price. The seller holds payments from the buyer as a fiduciary and is obligated to make the payments on the underlying loan.
Example: the property has a value of $1 million; the exist loan balance is $800,000. The buyer may make a $50,000 cash down payment, and finances the remaining $150,000 with an all inclusive deed of trust. The Seller receives principal and interest payments on the total $950,000 wrap around mortgage which he holds, but remains liable for and continues to pay the underlying $800,000 deed of trust.
An advantage for the buyer of using the wrap around for the buyer is that they may be able to negotiate a lower price and down payment. The buyer will also avoid paying the fees and coss of an institutional loan, or the assumption fee that may be required if he were able to assume the underlying loan.
Another possible, but inappropriate advantage to both parties, is the possibility of avoiding the due on sale clause in the underlying loan. The due on sale clause allows the lender, on transfer of title to the property, to call the entire loan balance as due and payable immediately. This is because the lender has made the loan based on the creditworthiness of the original buyer (now seller).
The assumption of the parties is that, as the seller continues to make payments on the underlying loan, the lender will not find out about the transfer. This may work for a while, but the parties cannot assume the lender will never find out, and should plan for the due on sale trigger. Lenders use tax and reporting services to notify them of changes involving their loans.
Given that economic signs are pointing to in increase in inflation throughout the country, and the new tougher requirements imposed by lenders, experienced real estate attorneys know that the wrap-around mortgage is likely to become popular again. In the next installment I will discuss drafting considerations for the all-inclusive deed of trust.