Wraparound mortgages in Colorado – are they legal? In short, yes, but it must be structured property to make sure your client is protected.
A typical owner carry is done with a free and clear property, where the seller deeds the property to the buyer, who signs a note for all or part of the purchase price, secured by a first lien (deed of trust) on the property in favor of the seller. A wraparound or “wrap” involves the sale of a property with seller financing, by leaving the existing loan in place. The buyer signs a note to the seller for all or part of the purchased price, which is secured by a “wrap” deed of trust in second position, behind the existing first. This deed of trust is referred to as an “AITD” or “All inclusive Deed of Trust”. The buyer pays the seller on the note, and the seller pays the underlying mortgage. When the buyer pays off the balance owed the seller, the seller then pays off the underlying mortgage and releases the AITD, allowing for clear title for the buyer. A third party escrow company is often used to collect the payment from the buyer and make the underlying payment on the first mortgage, to prevent a scenario where the seller decides to stop paying the first lien.
A wrap can be have a spread of equity and a markup of the interest rate (“equity wrap”) or can match the underlying loan balance and payment (“mirror wrap”).
The risks of the wrap for parties is the underlying lender finding out and enforcing the “due on sale” clause of the underlying mortgage. In this case, the buyer would have to either assume the first, or refinance with a new loan. Further, if the buyer fails to make payments on the wrap, the seller would have to go through a trustee foreclosure process to get the property back. If you are the seller, you may consider instead using a contract for deed (aka “installment land contract”). If unrecorded, the underlying lender is not likely to find out about the transfer. This can be risky for the buyer, since title remains in the seller’s name until the balance is paid, which means the seller could end up with liens on the property or file for bankruptcy, potentially jeopardizing the contract. Also, since Colorado has no specific process for canceling a contract for deed, the seller could end up having to do a long judicial foreclosure.
A wraparound sale should be done by a licensed attorney to make sure your interests are protected. If you are a licensed real estate broker in Colorado, you MUST have a licensed attorney prepare the contract and closing documents.
For representation on wraparound transactions, please call us at 303-398-7032.