Wraparound Transactions in Texas

Including Discussion of Texas Finance Code Regulation of Wraps

by David J. Willis J.D., LL.M.


A wraparound transaction is a form of creative seller financing that leaves the original loan and lien in place when a property is sold. The intention is that there be a conveyance to the buyer-borrower that:

(1) is subject to existing indebtedness that will be wrapped (the wrapped indebtedness);

(2) involves creation of a new note and lien (the wraparound note to the seller-lender) that is subordinate to the existing debt (the wrapped note); and

(3) takes place without advance approval by the existing lender (the wrapped lender).

In the typical wraparound closing, a buyer (who is also a borrower from the seller and thus a buyer-borrower) makes a down payment, gets title by means of a warranty deed, and signs a new note to the seller-lender (the wraparound note) for the balance of the sales price. This wraparound note, secured by a new deed of trust (the wraparound deed of trust), becomes a junior lien on the property behind the existing wrapped first-lien indebtedness. The prior existing wrapped note remains in place and unpaid. The buyer does not assume it. The wrapped note continues to be secured by the wrapped deed of trust which remains unreleased. This is why wraparound financing is sometimes referred to as subordinate-lien financing.

Wraparounds may be done in both residential and commercial transactions. It is possible to wrap more than one prior note (double wraps or even triple wraps). This chapter deals exclusively with residential wraps of a single prior note and lien.

The Wraparound Plan

The plan is for the buyer-borrower to monthly payments to the seller-lender on the wraparound note and the seller-lender in turn continues to make timely payments to the first-lien lender. This arrangement continues until the wraparound indebtedness is paid full.

At the time of full payment by the buyer-borrower, the seller-lender has several obligations: (1) to record a release of note and lien as to the wraparound note and wraparound deed of trust; and provide buyer with a file-stamped copy of same; and (2) to pay off the wrapped note and obtain and record a release signed by the wrapped lender. These obligations must be clearly set forth in the wraparound documentation.

Wraparounds are complex and creative real estate transactions that have a high failure rate. They call for thorough documentation that can appear unnecessarily lengthy and convoluted to the buyer and seller. There is no way around this. Brevity and simplicity are not virtues when it comes to the drafting of wrap docs.

Wraparound documents (including wrap earnest money contracts) that do not clearly and expressly address required statutory notices, the mechanics of how payments are handled and credited, insurance coverage, remedies available upon default, and all obligations of the parties up to and including the recording of the two necessary releases of lien are deficient per se and should not be signed.

Applicable Law

Legal regulation of wraps is extensive and includes:

Texas Property Code
Texas Finance Code
Safe Act (federal and state versions)
Dodd-Frank Law
Texas Department of Savings and Mortgage Lending (TDSML) regulations
Consumer Financial Protection Bureau (CFPB) rules
Deceptive Trade Practices Act
Real Estate License Act and TREC rules

The notion that such extensive legal compliance can be accomplished with brief and simplistic wrap documents is absurd—and yet practitioners routinely hear complaints from persons inexperienced in this area (including brokers, lawyers, and title companies, not to mention the parties) that wraparound documentation is too long or too complex. This is the result of fundamental inherent complexity along with expanded legal regulation. It is not the fault of lawyers who draft wraparound documents.

Professional Grade

Wraparounds are absolutely professional-grade transactions, especially after extensive regulations were added to the Finance Code in 2022. Wraps require professional-grade documentation starting with the contract. Attempting to handle a wrap casually, informally, or with overly-brief and simplistic documents that leave important terms to be assumed, implied, or deferred until later can result in failure of the transaction.


Commencing a Wraparound Transaction

Wrap documentation begins with the TREC 1-4 earnest money contract which should include a non-standard addendum (customized by an attorney) setting forth the specific terms of the wrap.

Realtors will often use the TREC Seller Financing Addendum (since there is no promulgated addendum for wraps) and let it go at that. This is entirely insufficient. The Seller Financing Addendum is not designed for wraps and must be supplemented by a specific wrap addendum in order to reflect the comprehensive wraparound agreement and obligations of the parties.

Written agreement as to all relevant wrap details should be reached at the contract stage. When the parties avoid confronting essential details at the contract stage, the transaction often fails to close. Why? Because at closing the parties are suddenly presented with wrap details and documentation that they did not want to think about. The reality of the wrap and its costs are driven home at that point. The collapse of a closing is what can happen when wraparound terms are not clearly articulated at the beginning of the process.

Wraparound Terminology

The wraparound indebtedness is to be distinguished from the wrapped indebtedness (which is the existing note to the seller’s lender—this is the indebtedness that is being wrapped).

The interest rate on a wrap note is often higher than that on the wrapped note since seller financing usually carries a rate slightly higher than market. Typical amortization is 15 or 30 years with an earlier balloon. In the past, most wrap notes ballooned in 3 to 7 years, giving the investor a reasonably short time horizon for realizing a profit. However, Dodd-Frank now requires that the seller affirmatively determine that the buyer has the ability to repay before a balloon may be used.

A short-term note for part of the down payment may also be included. For example, the seller-lender might agree to accept $20,000 down—$10,000 at closing and $10,000 paid over the next 180 days. For this, one needs to add a down payment note to the document list.

Wraparounds Versus Contracts for Deed

Contracts for deed belong to the general category of executory contracts which are real estate transfers where an important component of the transaction remains unaccomplished at closing. This unaccomplished part of an executory transaction is usually the execution and delivery to the buyer of a warranty deed (title) to the property.

Wraparounds are not executory contracts because they are fully accomplished (executed) at closing, including delivery of the warranty deed. In the event of default, the seller-lender must foreclose in order to get title to the property back, it not being sufficient to merely cancel the wrap. Although it is true that an existing lien (the wrapped note) remains, this does not prevent the transaction from being fully executed as to the immediate parties.

Delaying Delivery of the Deed

Some wraparound arrangements provide that the deed to the buyer will be held in escrow (perhaps by a lawyer) as security for a period of time—until the buyer pays in the full down payment, for instance. (Note that the down payment is occasionally financed in a wrap by a second shorter-term wrap note.)

In a deed-in-escrow scenario, the wrap paperwork states that the buyer is only leasing the property until the deed is actually delivered to the buyer. This is generally a bad idea. A material item of the transaction—the most material term, in fact—is unexecuted. Since the deal is unfinished, it is not a completed wrap but an executory contract subject to Property Code requirements and penalties (Prop. Code Sec. 5.061 et seq.). These penalties include a tie-in provision that makes violation of the executory-contract rules also a violation of the Deceptive Trade Practices Act (DTPA, Bus. & Com. Code Sec. 17.50 et seq.).

Security Deed as Seller Leverage

These are popular among wrap sellers though they are of dubious enforceability. The wrap buyer-borrower is given title at closing (as usual) but a security deed from the wrap buyer-borrower conveying the property back to the wrap seller-lender is also executed (but not recorded)—a variation of the deed in the drawer technique.

The idea is for the seller-lender to hold onto the security deed but only record it if the wrap buyer-borrower defaults. This would be done in lieu of going through a proper foreclosure pursuant to Chapter 51 of the Property Code. Problem is, the security deed may be an illegal “deed as mortgage” in violation of Chapter 21A of the Business & Commerce Code:

Bus. & Com. Code Sec. 21A.002. Prohibition of Execution of Deeds Conveying Residential Real Estate in Certain Transactions

(a) A seller of residential real estate or a person who makes an extension of credit and takes a security interest or mortgage against residential real estate may not, before or at the time of the conveyance of the residential real estate to the purchaser or the extension of credit to the borrower, request or require the purchaser or borrower to execute and deliver to the seller or person making the extension of credit a deed conveying the residential real estate to the seller or person making the extension of credit.

(b) A deed executed in violation of this section is voidable unless a subsequent purchaser of the residential real estate, for valuable consideration, obtains an interest in the property after the deed was recorded without notice of the violation, including notice provided by actual possession of the property by the grantor of the deed. The residential real estate continues to be subject to the security interest of a creditor who, without notice of the violation, granted an extension of credit to a borrower based on the deed executed in violation of this section.

To date, there is no known case interpreting this statute in the context of a wraparound.

It is worth recalling that real estate investors are not the most beloved of persons in the halls of justice. The common perception is that investors are greedy predators exploiting the unfortunate. Juries are often happy to award treble damages and attorney’s fees against investors, so caution is in order when using creative techniques designed to work around statutory requirements. These seldom survive court scrutiny.

Wraparounds Versus Assumptions

In an assumption, the buyer formally assumes the legal responsibility for paying the existing note. Sometimes this is done with the approval of the seller’s lender, paying an assumption fee and signing onto the debt; more often, the promise to assume the existing debt is made directly (and only) to the seller by means of an assumption deed. Either way, it is expressly stated that the buyer is taking on the legal obligation of paying and discharging the first-lien note.

This is not the case in a wrap. A wrap is a “subject to” transaction in which the wrapped first-lien note remains the sole responsibility of the seller. No assumption occurs.

In a wrap the first-lien note and the deed of trust securing it remain undisturbed. A new note (the wraparound note) secured by a new wraparound deed of trust is created. In other words, a wrap involves two separate and independent sets of payment obligations. The seller-lender continues to be obligated on the existing first-lien debt (the wrapped note) until it is paid and released; and the buyer-borrower is obligated to the seller-lender on a new wrap note and wrap deed of trust. These obligations coexist and the property becomes subject to both liens in order of priority.

Multiple Liens

It is possible to wrap more than one note and lien (e.g., a first and a second lien). The prior liens may even be to different lenders. The principle is the same: the buyer-borrower pays the seller-lender on the wraparound note, and the seller-lender then pays both prior notes. The lien securing the wraparound note is subordinate and inferior to both of the prior liens. Both loans will require a recorded release of note and lien when the wraparound note is paid.

Example of a Wraparound

Consider the example of 123 Oak Street which is valued at $100,000 but has been slow to move. There is a first lien in the amount of $50,000 to Apple Bank and a second lien in the amount of $25,000 to Orange Bank which, taken together, result in $25,000 equity. In the usual case, a purchaser would make a down payment and obtain third-party institutional financing, allowing the seller to receive his equity at closing and go happily on his way. But what if the buyer is unable to get traditional financing? The solution may be a seller-financed wrap note in a premium amount—say $110,000—which is subordinate to the notes due Apple and Orange Banks. The wrap note will likely bear a higher than market rate of interest. It will be secured by a wrap deed of trust that enables the seller to foreclose if the buyer-borrower defaults on the wrap note.

Is a wrap a device to get sub-prime buyers into homes?

Perhaps, but prudent investors will nonetheless require the buyer-borrower to have a substantial down payment. The seller-lender should evaluate and approve the buyer-borrower’s qualifications as would any other lender. In fact, Dodd-Frank requires this with its ability-to-repay (ATR) rule (12 C.F.R. Sec. 1026.43(c)(1)). A wraparound is a legitimate device to sell property to reasonably qualified buyers who have money to put down and can afford the monthly payments.

Can wraps be used in conjunction with land trusts?

Yes. There are circumstances where it may be a good idea to first transfer the property into a land trust and then do a wrap, but this requires more complex documentation since a trust agreement will also have to be prepared.

Residential Versus Commercial Wraps

Both residential and commercial wraps are possible. Commercial deeds of trust are more likely, however, to contain a due-on-sale provision that actually prohibits any transfer of title without prior lender consent—meaning that selling the property on a wrap would be a default by the existing owner.

This contrasts with most residential due-on-sale clauses that only threaten possible acceleration if the borrower transfers title without lender consent. The Fannie Mae/Freddie Mac uniform deed of trust is not an outright prohibition; it merely gives the lender the option to accelerate the note if it wishes to do so.

Note that Finance Code rules pertaining to wraparounds do not apply to commercial transactions.

In all cases, but especially in commercial cases, one should carefully review the existing deed of trust before proceeding with a wrap.

Why would a seller do a wrap?

A wrap seller can often sell at a higher-than-market price. The seller gets some cash today (the down payment) which either goes into the seller’s pocket or is used to reduce principal on the wrapped note (or a negotiable combination of both). The seller is then out from under the payment burden, although he or she must continue to be involved in the mechanics of collecting and forwarding payments to the first lienholder unless a third-party servicer is used. The seller also gets the benefit of any spread between the interest rate on the wrapped note and wraparound note.

Why would a buyer do a wrap?

A wrap buyer does not have to apply and qualify for a new loan, at least not immediately (The wraparound agreement may provide that the buyer must refinance the wraparound loan within a certain period.) The buyer gets both title and immediate possession without lengthy application delays, expensive loan fees, and closing costs.

Why would a broker encourage a wrap transaction?

Firstly, the wrap transaction may meet the objectives of the broker’s client, and the broker is under a fiduciary obligation to see that this occurs. Secondly, the buyer’s down payment supplies cash for the broker’s commission to be paid at closing just as with a conventional transaction.

Is a wrap transaction a breach of contract with the lender?

No, at least not in most residential transactions. As noted above, doing a wrap is neither a breach nor a violation of the due-on-sale clause found in the FNMA deed of trust. This clause provides that a lender may (not must) choose to accelerate. Transfer of title is not prohibited and if it occurs the lender may pursue action at the lender’s discretion. This is quite different from an actual breach or violation of a covenant with the lender.

As a practical matter, mortgage lenders are not usually interested in foreclosing upon a performing loan on technical grounds such as transfer of title by the borrower. However, some will send irate letters demanding that the new owner apply and qualify to assume the loan, threatening that the property could be posted for foreclosure.

Statistically speaking—and this could change—actual acceleration of a performing loan based on due-on-sale seldom happens in today’s environment. However, if interest rates climb, lenders may acquire an incentive to call low-interest loans due and replace them with higher-rate loans.

Down Payment on a Wrap

In wraparounds, the seller of the property is also the lender and (like any lender) should carefully consider the risks inherent in the transaction as well as the borrower’s creditworthiness and ability to repay—all of which should be examined before determining the amount of down payment and what interest rate to charge. Dodd-Frank requires such due diligence. Regardless of the borrower’s qualifications, it is likely that wraps with no down payment will fall within the risky category and be of questionable legality under Dodd-Frank.

Can part of the down payment be financed? Yes. There is no prohibition against it. In such cases, the buyer-borrower pays part of the down payment at closing and then promises to pay the balance within a short period—say 90 to 180 days—utilizing a second wrap note (a short-term down-payment note). Again, this is an underwriting issue for the seller-lender but it is a common enough practice.

What if both notes are due on the first of the month?

In a wrap, there are now two monthly notes that need to be paid. The timing of payments is important and should be addressed in both the wraparound note and the wraparound agreement. It is a good idea to schedule payments on a wrap note seven to ten days before wrapped-note payments are due in order to allow the seller-lender sufficient time to forward funds to the wrapped lender.

Double Wraps

So long as the wrap deed of trust permits it, a wrapped loan can be wrapped and wrapped again, although the documentation can become prolific. This permits an investor to purchase property on a wraparound and then sell it the same way (likely at a higher price and interest rate), collecting a down payment (the investor’s front-end profit) from a new buyer in the process. Usually, this new buyer commits to go through credit repair with the goal of paying off the wrap note early, at which time the investor gets his back-end profit.

While double wraps look good on paper, around 90% of them collapse in the real world, mostly due to their complexity.

The Interest Deduction

After a transaction is closed, the seller continues to be able to deduct interest paid on the wrapped loan. Nothing changes there. As to interest on the wrap note, interest received by the seller-lender must be reported as income, and interest paid by the buyer-borrower on the wraparound note is deductible.

Closing the Wrap with Title Insurance

A title company closing is now the preferred way to go since passage of Finance Code Section 159.105 (which states that a lien securing a wraparound loan is void unless the loan and conveyance are closed at a title company or in an attorney’s office).

Some title companies are more inclined to insure wraps than others. It may be necessary to shop title companies until a wrap-friendly title company is found. Be prepared to meet any additional underwriting requirements they may impose.

If a buyer-borrower wants an owner’s policy of title insurance, then closing will be held either at a title company or at the office of a fee attorney acting as agent for a title company. Now that regulation of wraps has been significantly expanded, this is actually better for everyone.


Default by the Wrap Buyer

In a wraparound, the seller-lender receives a wrap deed of trust that enables the seller-lender to foreclose if the buyer-borrower defaults in payment of the wrap note. The seller-lender can also seek and obtain a deficiency judgment if the sales price at foreclosure is insufficient to discharge the wrap note including accrued interest and fees. Accordingly, the seller-lender has the same ability to enforce the wrap note and lien as does any other lender. The foreclosure of a wrap is no different from foreclosing on any other ordinary deed of trust lien.

Texas is fortunate to have an expedited non-judicial foreclosure process. Property Code Section 51.002 requires that a homeowner be given at least a 20-day notice of default and intent to accelerate the note if the default is not timely cured. If the deed of trust is on the FNMA form (which would be unusual for a wrap) then a 30-day notice and opportunity to cure is required. The default notice must be followed by a second letter stating that since the default was not cured, the note is being accelerated and the property is being posted for foreclosure. This second notice must be given at least 21 days before the first Tuesday of the month in which the foreclosure will be held.

Most Texas residential foreclosures take a minimum of 41 days—51 days if a FNMA deed of trust is involved—although one should always avoid cutting it close when it comes to legal notices. It is prudent to allow a cushion for the unexpected.

Default by the Wrap Seller

The wrap agreement should provide that if the wrap seller fails to make payments to the wrapped lender, the buyer-borrower may do so and receive credit against the wrapped note. The buyer-borrower should also have the power to request documentary proof from the seller-lender that the wrapped note is current.

Finance Code Section 159.202 gives the buyer-borrower a right to deduct if the wrapped lien is not being timely paid by the seller-lender. See part two of this chapter for details.

Two related situations are of interest: what happens if the seller (1) files bankruptcy and seeks discharge of the wrapped debt, or (2) dies leaving the wrapped debt unpaid? In either case, the buyer-borrower could be forced to refinance the debt on short notice, which may be challenging.

In the case of seller bankruptcy, the seller should agree to execute a reaffirmation agreement on the wrapped debt rather than surrendering the property to the wrapped lender.

As for the seller’s premature death, the buyer should check to see if the seller has or can add term life protection (payoff insurance). If not, the buyer might consider obtaining a term life insurance policy on the seller in the amount of the wrapped debt.


The Casualty Insurance Problem

Sellers in wrap transactions nearly always want to cancel their casualty insurance policy. This has consequences. The wrapped lender, which usually collects an escrow or at the very least is named as additional insured, will be notified of the cancellation, which it will view as a default under its deed of trust. The wrapped lender will not be happy and will force place another policy (usually a more expensive one) at the seller’s expense.

There is also an issue relating to the concept of insurable interest. What happens if there is a loss? Collecting on the seller’s insurance policy can be problematic since title to the property changed hands at closing of the wrap. The owner of record is now the wrap buyer, but the old policy names the seller as loss-payee. Even if the seller agrees to make a claim on behalf of the buyer, the insurer may refuse to pay it, asserting that the seller no longer owns the property and thus no longer has an insurable interest. Worse, this could potentially be construed as insurance fraud.

There are good reasons that Finance Code Section 159.101 requires that wrap buyer-borrowers be warned about potential insurance pitfalls.

What is the solution? The existing policy should be maintained and the wrap buyer-borrower should also procure separate casualty and contents insurance. Any claims that arise should be made pursuant the buyer’s policy.

It is unfortunate that this results in two policies but there may be no way around it. Wrap closings often fail on this issue, since wrap sellers typically assume that they will be able to cancel the existing policy and avoid that expense after closing.

The subject of insurance (and other wrap-relevant topics) should be thoroughly addressed in a custom wraparound addendum to the contract. It is amateurish not to deal with the difficult details of a wrap—up front and in advance—so everyone knows at the contract stage what they are getting into. Failure to do this is the #1 reason wraps fail at the closing table.

Delayed Investor Profit

There are shortcomings to a wrap. For instance, the seller-lender has to wait until the wrap note matures in order to receive the full proceeds of the sale. Also, the wrapped loan is frozen in place and cannot be refinanced for the duration of the wrap. Unless the seller-lender utilizes a third-party servicer, the seller-lender must collect and remit payments, which requires ongoing involvement. If the wrap buyer-borrower defaults, the seller-lender must foreclose. In the unlikely event a loan is accelerated, the buyer—borrower may have to quickly secure traditional financing, so the wraparound agreement should specify the amount of time in which this must be done. Finally, as noted previously, the parties may also be carrying duplicate casualty insurance policies.

Some caution is in order as to the duration (term) of the wraparound note. Statistically, the wrap is more likely to be successful the longer the time the borrower has to find substitute financing. Wraps with a two-year balloon have a high mortality rate.

Wraparounds are useful devices, but they are not perfect.


Get Early Agreement on the Details

A properly conducted wraparound transaction will, from the outset, recognize the non-standard nature of the transaction and the need to properly document the details of how payments will handled and credited, insurance coverage, default remedies, and all obligations of the parties up to the point where two releases of lien are filed that conclude the wrap transaction.

All parties should be prepared for what is to come in the way of details and documentation. While everyone wants to get a contract signed and open title, this is not the time to pretend that the transaction and its documentation will be simple and easy.

The wraparound process begins with a TREC 1-4 Contract, the usual relevant addenda, including the Seller Financing Addendum, and a custom wraparound addendum. The goal is to explain everything, assume nothing, leave nothing to be resolved later, and get it all in writing up front.

Custom Wrap Addendum to the Contract

Why is a custom wraparound addendum so important? There are quite a few items that need to be addressed and agreed upon early in the process:

Wraparound Agreement of the Parties

obligation of buyer to pay new wrap note
obligation of seller to pay existing wrapped lender
casualty insurance issues (double-coverage)
seller’s duty to provide two releases at the end
remedies upon default by either party
disclosure of due-on-sale clause
what happens if the wrapped lender accelerates?
is the contract assignable?

Description of the Wrapped Indebtedness

wrapped note: date, amount, parties
wrapped deed of trust; date, trustee, recording information
current owner and holder of the note
servicer of the note
loan number and escrow details

Wraparound Note Terms

principal amount, term, and interest rate in wrap note
amount of payments and date they commence
balloon provision in wrap note?
escrow to be collected?
does seller collect payments or a third-party servicer?
due-on-sale clause in wrap deed of trust?

Wraparound Deed of Trust Terms

notice and opportunity to cure
due-on-sale clause included?
non-recourse clause included?
substitution of collateral clause?
may buyer lease the property?
reinstatement requirements after acceleration

Wraparound Legal Documents

who will prepare these?
does the non-drafting party have a right to review?
general versus special warranty deed
“as is” clause in the warranty deed?
assignment of existing lease and security deposit?

The foregoing key wraparound terms will have to be dealt with sooner or later. If the parties do not have clear agreement on these points beginning at the contract stage then they really do not have a wraparound agreement at all. Leaving important legal terms unaddressed, assumed, implied, or just left for later causes the chance of a successful closing to drop dramatically.

Wrap Documents at Closing

A closing package of wrap documents would include (at minimum):

(1) a general warranty deed with vendor’s lien containing wrap-specific language;

(2) a new wraparound note signed by the buyer and payable to the seller (which is subordinate to the existing wrapped note);

(3) a wraparound deed of trust securing payment of the wraparound note;

(4) a wraparound agreement covering comprehensive agreement of the parties;

(5) a general assignment to the buyer of warranties, utility deposits, Insurance Proceeds, property management and maintenance contracts, and (if the property is rented to a tenant) an assignment of lease, rents, and security deposit;

(6) a special power of attorney enabling the buyer to obtain payoff information from the wrapped lender as well as to endorse and deposit to its own account any refund checks for same.

(7) while not a required transactional document, there should be a worksheet or checklist in the seller’s file evidencing the seller’s good-faith compliance with Dodd-Frank’s ability-to-repay (ATR) rule.

Wrap terms can vary widely. There may also be a down-payment note involved. Other custom features and special agreements of the parties may need to be documented.

The Wraparound Agreement

A stand-alone wraparound agreement should be a core closing document. This is more than just a catch-all document for miscellaneous details. It should be a master document that contains all key covenants and agreements of the parties.

For instance, how will the buyer’s wrap note payments be handled? This is an example of a wraparound agreement clause addressing this issue:

Seller covenants and agrees to cause the entire amount of Buyer’s monthly payments on the Wraparound Note to be applied first to full and timely payment of installments as they fall due on the Wrapped Note. Seller shall not divert Buyer’s payments intended to cover such Wrapped Note installments to any other account or purpose.

Another example: what happens when the buyer performs and pays the wraparound note in full? It is vital to expressly set forth the seller’s obligations at that point:

Upon payment in full of the Wraparound Note by Buyer, Seller covenants and agrees to within 90 days of receipt of payment: (a) execute and record a Release of Note and Lien as to the Wraparound Note and Wraparound Deed of Trust; (b) pay any and all indebtedness remaining unpaid on the Wrapped Note; and (c) procure a duly executed and acknowledged full and complete Release of Note and Lien from the Wrapped Lender and cause same to be promptly recorded in the real property records of the county where the Property is located.

Leaving such critical deal points unaddressed or subject to the good will and cooperative spirit of the parties is risky indeed. In no other professional-level business transaction would these be left to be assumed, implied, or deferred until later.

Substitution of Collateral Clauses

In discussing wraparound documentation it is worth mentioning substitution of collateral clauses. Such clauses permit the subject property to be freed from the wrap lien (i.e., the lien imposed by the wraparound deed of trust) so long as a different property of reasonably equivalent value is substituted in its place. If the wrap buyer-borrower is a real estate investor with multiple properties this can be a useful and flexible strategy.


Law Applicable to Wraps

Law and rules applicable to wraparounds range across the Texas Finance Code, the Texas Property Code, the Safe Act (both federal and state versions), Dodd-Frank, rules made by the Texas Department of Savings and Mortgage Lending, regulations promulgated by the federal Consumer Financial Protection Bureau, and (of course) case law. If one is a real estate license holder, then the Real Estate License Act and TREC rules come into play. And, as is true with most consumer transactions, there is the Deceptive Trade Practices Act to contend with.

We will begin by examining relevant provisions of the Finance Code.

Finance Code Regulation of Wraparounds

The Finance Code is at the center of wraparound regulation. TFC Chapter 159 is entitled “Wrap Mortgage Loan Financing” and broadly applies to all residential wraps (and all lenders and loan originators) unless it expressly says otherwise.

The TFC was significantly amended (effective in 2022) to beef up coverage of wraparounds. Licensing and registration requirements for wrap sellers were added as were disclosure requirements, investigation and enforcement provisions, and an administrative penalty.

The licensing requirement is found in Section 159.051:

TFC Sec. 159.051. License or Registration Required

A person may not originate or make a wrap mortgage loan unless the person is licensed or registered to originate or make residential mortgage loans under Chapter 156, Chapter 157, or 342 [of the Finance Code] or is exempt from licensing or registration as provided under an applicable provision of those chapters.

Rules Implementing the Finance Code

The Department of Savings and Mortgage Lending (subject to the oversight and under the jurisdiction of the Texas Finance Commission) is charged with adopting and enforcing rules necessary for investigation and enforcement of wraparound law. TDSML rules may be found in Chapter 78 of the Texas Administrative Code and are posted on the secretary of state’s website.

Definition of a Wraparound Transaction

What qualifies as a wraparound transaction according to the TFC? Section 159.001(7) states that a wraparound mortgage loan is “a residential mortgage loan made to finance the purchase of residential real estate that will continue to be subject to an unreleased lien that attached to the residential real estate before the loan was made; and secures a debt incurred by a person other than the wrap borrower that was not paid off at the time the loan was made; and obligating the wrap borrower to the wrap lender for payment of a debt the principal amount of which includes the outstanding balance of the debt and any remaining amount of the purchase price financed by the wrap lender.” This definition is conventional and consistent our ordinary understanding of what constitutes a wrap.

Exemptions to Wraparound Regulation

A quick reading of the statute makes it clear that the Finance Code intends to target real estate investors who use wraparounds in selling a substantial number of single-family homes each year. TFC Section 159.003(4) exempts any owner of residential real estate who in any twelve consecutive-month period makes no more than three residential mortgage loans to purchasers of property for all or part of the purchase price of the residential real estate against which the mortgage is secured.

Note that this would include any form of seller financing, not just wraparounds (TFC Sec. 157.0121(c)(2) and 159.003(4)).

The Finance Code requirements do not apply to unimproved residential real estate (defined as residential real estate on which a dwelling has not been constructed) so long as the holder of [the] unreleased lien has consented to the sale of the residential real estate. . .” (TFC Sec.159.002 (a) and (b)).

The statute does not apply to “a sale of residential real estate that is the wrap lender’s homestead” (TFC Sec. 159.002(b)(2)).

Lenders and loan originators are exempt from the rules if they are federally-regulated lenders, non-profits, licensed mortgage brokers, or Section 501(c)(3) organizations. Employees of these organizations are also exempt.

Combining Entities Does Not Avoid the Rules

The statute anticipated that creative wrap seller-lenders and their attorneys would attempt to run around the de minimis rule by setting up entities for that purpose, so it provides specifically that one may not exceed the number of seller-financed transactions (including wraps) allowed under the de minimis rule by utilizing an LLC or other entity as a front for doing additional wraps. The rules apply in a combined way to an individual as well as that person’s affiliated entities: “In determining eligibility for an exemption under Subsection (a-1)(3), two or more owners of residential real estate are considered a single owner for the purpose of computing the number of mortgage loans made within the period specified by that subdivision if any of the owners are an entity or an affiliate of an entity, including a general partnership, limited partnership, limited liability company, or corporation. . .” (TFC Sec. 157.0121(f) and 159.003(b)).


Notices under the Property Code and the Finance Code are designed to alert wraparound buyers that there is an existing unpaid lien against the property and to warn of potential insurance coverage issues.

Required Seller Notice under Prop. Code Sec. 5.016

Property Code Section 5.016 is entitled “Conveyance of Residential Property Encumbered by Lien.” Since this is exactly what wraparounds do, this statute is directly applicable. Property Code Section 5.016 requires that the seller give a notice that includes the following warning:


The notice must: (1) give seven days’ notice to the buyer before closing that an existing loan will remain in place; and (2) inform the buyer that buyer has this same seven-day period in which to rescind the earnest money contract without penalty. The same notice must be given to the lender. These notices are all the obligation of the seller. There are no notice requirements imposed on buyers by Section 5.016.

Section 5.016 notices must include: (1) an identification of the property; (2) the name, address, and phone number of each wrapped lienholder; (3) the amount of debt that is secured by each existing lien; (4) a summary of the terms of any contract or law under which the existing loan to be wrapped is secured including the interest rate, the amount of monthly payments, and the account number; (5) the details of any insurance policy relating to the property including the name of the insurer and insured as well as the amount for which the property is insured; and (6) the amount of the property taxes. It must also be stated clearly whether or not the existing lienholder (the wrapped lender) has consented to the wraparound.

Note that lender consent is not required. Lender notices, often sent to the loan servicer, generally produce no response.

The Department of Savings and Mortgage Lending has promulgated a model disclosure statement that may be found on the agency’s website.

Exceptions to Property Code Notice Requirements

Exceptions to the notice requirements are made for certain transfers including from one co-owner or spouse to the other. Property Code Section 5.016(c)(10) also provides an exception to the notice requirement when “the purchaser obtains a title insurance policy insuring the transfer of title to the real property.” Thus if you close at a title company you may dispense with seven-day notices. Professional investors (those who have “purchased, conveyed, or entered into contracts to purchase or convey real property four or more times in the preceding 12 months”) need not be given the notice (Prop. Code Sec. 5.016(c)(11)).

The buyer’s cancellation remedy for seller’s failure to give the seven-day notice is an exclusively pre-closing remedy. There is no right of rescission on this basis after closing.

Seller Notice Requirement under the Finance Code

This notice requirement is in addition to the one previously discussed. Under Finance Code Section 159.101, a wrap seller-lender must, on or before the seventh day before the wrap mortgage loan agreement is entered into, provide to the wrap borrower a separate written disclosure statement in at least 12-point type warning that insurance coverage can be problematic:


The notice required by Section 159.101 must be given to the wraparound buyer-borrower on or before the seventh day before the wrap mortgage loan agreement is entered into (interpreted to mean the date of closing). It must be dated and signed by the wraparound borrower when the wrap borrower receives the statement.

There is also a foreign language requirement. If negotiations preceding execution of the wrap closing documents are conducted primarily in a language other than English, the wrap seller-lender must provide the required disclosures in the language to the wrap buyer-borrower (TFC Sec. 159.102).

Exceptions to Finance Code Notice Requirements

Finance Code seller-notice requirements do not apply to unimproved residential real estate (defined as residential real estate on which a dwelling has not been constructed) so long as the holder of [the] unreleased lien has consented to the sale of the residential real estate. . . .” (TFC Sec.159.002 (a) and (b)). The statute does not apply to “a sale of residential real estate that is the wrap lender’s homestead” (TFC Sec. 159.002(b)(2)).

Notice requirements under the Finance Code do not apply to “an owner of residential real estate if the owner does not in any 12-consecutive-month period make, or contract with another person to make, more than three wrap mortgage loans to purchasers of the property for all or part of the purchase price of the residential real estate against which the mortgage is secured” (TFC Sec. 159.003(4)).


Buyer’s Right of Recission

There are several specific recission rights granted by Finance Code Section 159.104:

Disclosures Timely Provided—Right of Recission. If the required disclosures are timely given and received prior to closing, the wrap buyer-borrower may rescind the transaction not later than the 7th day after the date of receipt of the disclosure statement.

Failure to Provide Disclosures—Right of Recission before Closing. If the required disclosures are not given and received before closing, the wraparound borrower may rescind the wrap mortgage loan agreement and the related purchase agreement at any time by providing the wrap lender notice of rescission in writing.

Failure to Provide Disclosures—Right of Recission after Closing. If the required disclosures are given and received by the wrap buyer-borrower after closing (but before any notice of recission is given) then the wrap buyer-borrower may rescind the wrap transaction in writing on or before the 21st day after the date of receipt of the disclosures. The wrap seller-lender must pay to the wrap buyer-borrower as damages for noncompliance the sum of $1,000 plus any reasonable attorney’s fees incurred by the wrap buyer-borrower.

Recission Amounts Due to the Wrap Buyer-Borrower. Upon recission, and not later than the 30th day after the date of recission, the wrap buyer-borrower is entitled to the return of any earnest money, escrow amounts, down payment, and other fees or charges that have been paid to the wrap seller-lender. TFC Sec. 159.101(d).

Avoidance of Recission by Wrap Seller-lender. Notwithstanding the above, the wrap seller-lender may avoid recission if not later than the 30th day after receiving the recission notice, the wrap seller-lender entirely pays off the wrapped loan (no mention is made of providing or recording a release of lien); pays any taxes due on the property; and pays to the wrap buyer-borrower $1,000 plus reasonable attorney’s fees. The wrap seller-lender is required to provide evidence of the foregoing actions. TFC Sec. 159.104(e)(1-4).

Tolling of the Statute of Limitations. If a wrap seller-lender fails to provide the disclosure statement as required by Section 159.101 or fails to provide disclosures in the language required by Section 159.102, the limitations period applicable to any cause of action of the buyer-borrower against the wrap seller-lender arising out of the wrap seller-lender’s violation in connection with the wrap transaction is tolled until the 120th day after the date the required disclosure statement is provided. TFC Sec. 159.103.

On the date when all funds are returned to the wrap buyer-borrower, the buyer-borrower shall re-convey the property to the wrap lender or its designee and surrender possession within 30 days (TFC Sec. 159.104(d)). This provision also has the effect of stipulating the date on which the re-conveyance must be effective.

Buyer’s Right to Deduct

The buyers’ rights section of the Finance Code applies only to wrap loans made for the purchase of residential real estate to be used as the wraparound borrower’s residence (TFC Sec.159.201). Three important items are included in this section:

Right to Deduct. The Finance Code allows the wrap buyer-borrower a right to deduct in the event that the wrapped lender is not being timely paid. TFC Sec. 159.202 provides that the “wrap borrower, without taking judicial action, may deduct from any amount owed to the wrap lender under the terms of the wrap mortgage loan: (1) the amount of any payment made by the wrap borrower to an obligee of a debt described by Section 159.001(7)(A)(ii) to cure a default by the wrap lender caused by the lender’s failure to make payments for which the lender is responsible under the terms of the wrap mortgage loan; or (2) any other amount for which the wrap lender is liable to the wrap borrower under the terms of the wrap mortgage loan.”

This provision is meaningful only if the wrap buyer-borrower has a means of ascertaining the status of the wrapped loan (the online login information, for instance). Otherwise, the wrap buyer-borrower may not be aware of any default issues with the wrapped loan until the property is posted for foreclosure by the wrapped lender—or worse, when a constable serves a forcible detainer (eviction) action after foreclosure has occurred.

Interestingly, the right to deduct provision does not require the wrap buyer-borrower to apply deducted funds to the cure of a default under the wrapped mortgage loan. Assuming, however, that the wrap buyer-borrower does so, then the right to deduct provision becomes the equivalent of a right to cure for purposes of avoiding foreclosure on the home.

Fiduciary Duty. The collection of payments from a wrap buyer-borrower is subject to a fiduciary duty owed by wrap seller-lender to the wrap buyer-borrower. Finance Code Sections 159.151 and 159.152 state: “A person who collects or receives a payment from a wrap borrower under the terms of a wrap mortgage loan holds the money in trust for the benefit of the borrower. . . . A person who collects or receives a payment from a wrap borrower under the terms of or in connection with a wrap mortgage loan owes a fiduciary duty to the wrap borrower to use the payment to satisfy the obligations of the obligee under each [wrapped loan as well as] the payment of taxes and insurance for which the wrap lender has received any payments from the wrap borrower.”

It has long been a concern of residential wrap buyer-borrowers that the wrap seller-lender may not use monthly payments on the wrap note to discharge the underlying wrapped lien. The duty of the wrap seller-lender to make payments on the underlying loan is usually taken for granted as if it were a negligible term—when it is in fact at the very core of the wraparound relationship. However, absent a provision in a wrap agreement, the wrap seller-lender previously had no express duty in this area. The 2022 amendments to the Finance Code attempt to cure this problem by adding the right to deduct.

Query: Why not just expressly state that the wrap seller-lender has an affirmative duty to use the wrap buyer-borrower’s monthly payments for the purpose of paying down the wrapped loan? Or did the statute drafters believe that imposing a fiduciary duty would cover this issue? In any case, a well-drafted wraparound agreement will make this duty clear.

Waivers Prohibited. Any purported waiver of a wrap buyer-borrower’s rights or purported exemption of a person from liability for violation of the above rules (no matter how cleverly worded) is void. “A person who is a party to a residential real estate transaction may not evade the application of this subchapter by any device, subterfuge, or pretense, and any attempt to do so is void and a deceptive trade practice. . . .” TFC Sec. 159.107. The tie-in with the DTPA gives this provision extra power since the DTPA broadly prohibits “any unconscionable act or practice”—something easily found by jurors when they want to punish a defendant (Bus. & Com. Code Sec. 17.50 et seq.).

When combined, the right to deduct, the lender’s fiduciary duty, and the no-waiver provision go a long way toward redressing the disparity of rights and power that has previously been inherent in Texas wraparound transactions.

Remedies of Wrap Buyers

If wrap provisions of the Finance Code are violated, a wrap buyer-borrower may bring a lawsuit against the wrap seller-lender to: (1) obtain declaratory or injunctive relief to enforce Code provisions; (2) recover any actual damages suffered by the wrap buyer-borrower as a result of the violation; or (3) obtain other remedies by using the Deceptive Trade Practices Act, which is a very significant weapon in the hands of a competent plaintiffs’ attorney. The wrap buyer-borrower who prevails in a suit against the wrap seller-lender may recover court costs and reasonable attorney’s fees (TFC Sec. 159.106).

An additional remedy (of sorts) is the ability of the wrap buyer-buyer to report a violation to the Department of Savings and Mortgage Lending which may then launch an investigation, although this remedy is limited by Section 159.251 to registered wrap lenders—a puzzling and unfortunate limitation. The investigatory process is outlined in Section 159.252(a):

TFC Sec. 159.252. Inspection; Investigation

(a) The [Finance Commissioner] may conduct an inspection of a wrap lender registered under Chapter 158 as the commissioner determines necessary to determine whether the wrap lender is complying with that chapter and applicable rules. The inspection may include an inspection of the books, records, documents, operations, and facilities of the wrap lender. The commissioner may share evidence of criminal activity gathered during an inspection or investigation with any state or federal law enforcement agency.

(b) For reasonable cause, the commissioner at any time may investigate a wrap lender registered under Chapter 158 to determine whether the lender is complying with that chapter and applicable rules.

(c) The commissioner may conduct an undercover or covert investigation only if the commissioner, after due consideration of the circumstances, determines that the investigation is necessary to prevent immediate harm and to carry out the purposes of Chapter 158.

(d) The finance commission by rule shall provide guidelines to govern an inspection or investigation under this section, including rules to: (1) determine the information and records of the wrap lender to which the commissioner may demand access during an inspection or investigation; and (2) establish what constitutes reasonable cause for an investigation.

(e) Information obtained by the commissioner during an inspection or investigation under this section is confidential unless disclosure of the information is permitted or required by other law.

(f) The commissioner may share information gathered during an investigation under this section with a state or federal agency. The commissioner may share information gathered during an inspection with a state or federal agency only if the commissioner determines there is a valid reason for the sharing.

(g) The commissioner may require reimbursement of expenses for each examiner for an on-site examination or inspection of a registered wrap lender under this section if records are located out of state and are not made available for examination or inspection by the examiner in this state. The finance commission by rule shall set the maximum amount for the reimbursement of expenses authorized under this sub-section.

Information obtained during an investigation may be shared with “a state or federal agency” (TFC Sec. 159.252(f)). The clear implication here is that the Commission may make criminal referrals to state and federal prosecutors. This continues the decades-long trend in U.S. law of effectively criminalizing offenses that were previously civil in nature.


Subpoena Power

During an investigation, a subpoena may be issued requiring a person to give a deposition, produce documents, or both. If a person disobeys the subpoena, refuses to appear for a deposition, or refuses to testify, the Department of Savings and Mortgage Lending may turn to the Travis County District Court for assistance, specifically a court order requiring the person to obey the subpoena, testify, or produce documents.

This provision opens an important door to enforcement by means of judicial contempt (TFC Sec. 159.253(b)). Although contempt in this event would be a civil and not a criminal matter, a real estate investor sitting in jail could be forgiven for not appreciating the difference.

Cease and Desist Order

If there is reasonable cause to believe that a wrap lender or wrap mortgage loan originator is in violation, the Finance Code provides for an administrative remedy:

TFC Sec. 159.301. Cease and Desist Order

(a) [The Finance Commissioner] may issue without notice and hearing an order to cease and desist from continuing a particular action or an order to take affirmative action, or both, to enforce compliance with this chapter. (b) An order issued under Subsection (a) must contain a reasonably detailed statement of the facts on which the order is made. If a person against whom the order is made requests a hearing, the commissioner shall set and give notice of a hearing before the commissioner or a hearings officer. The hearing shall be governed by Chapter 2001, Government Code.

(b) . . . based on the findings of fact, conclusions of law, and recommendation of the hearings officer, the [Finance] commissioner by order may find a violation has occurred or not occurred.

(c) If a hearing is not requested under Subsection (b) on or before the 30th day after the date on which an order is made, the [Finance Commissioner’s] order is considered final and not appealable.

(d) The [Finance] commissioner, after giving notice and an opportunity for hearing, may impose against a person who violates a cease and desist order an administrative penalty in an amount not to exceed $1,000 for each day of the violation. In addition to any other remedy provided by law, the commissioner may institute in district court a suit for injunctive relief and to collect the administrative penalty. A bond is not required of the commissioner with respect to injunctive relief granted under this sub-section.

Exemptions from Finance Code Enforcement

Finance Code Section 180.003 provides that certain persons are exempt from investigation and enforcement:

(1) a registered mortgage loan originator when acting for a licensed entity;

(2) an individual who offers or negotiates terms of a residential mortgage loan on behalf of an immediate family member;

(3) a licensed attorney who negotiates the terms of a residential mortgage loan on behalf of a client as part of the attorney’s representation of the client, unless the attorney either takes a residential mortgage loan application or offers or negotiates the terms of the residential mortgage loan;

(4) an individual who offers or negotiates terms of a residential mortgage loan secured by lien on the individual’s residence;

(5) an owner of residential real estate who in any 12-consecutive-month period makes no more than three seller-financed residential mortgage loans; and

(6) an owner of a dwelling who in any 12-consecutive-month period makes no more than three seller-financed residential mortgage loans.

The same rule against combinations applies as elsewhere in the statute, i.e., “two or more owners of residential real estate are considered a single owner for the purpose of computing the number of mortgage loans made within the period specified by that subdivision if any of the owners are an entity or an affiliate of an entity, including a general partnership, limited partnership, limited liability company, or corporation. . . .” (TFC Sec. 180.003(d)). Accordingly, setting up additional entities solely for the purpose of evading Finance Code transactional limitations is to no avail.



Since wraps are a form of seller financing, any law that applies to seller financing applies to wraps. Federal laws on this subject include the SAFE Act (or T-SAFE as it is implemented in Texas) and Dodd-Frank.

The SAFE Act (TFC Sec. 180.001 et seq.) imposes a licensing requirement on certain types of seller financing extended by persons who are regularly engaged in offering such financing in the sale of residences. A seller-lender is required to be licensed as an RMLO if the property is not the seller’s homestead and/or if the sale is not to a family member. So, if the property is a rental house (i.e., not the seller’s homestead) that is being sold to a non-family member, then the seller is required to have an RMLO license, which requires training, a background check, and an exam. This licensing rule applies only to residential wraps and is not applied to persons making three or fewer seller-financed residential loans in a year.


Dodd-Frank (Title XIV of the federal Mortgage Reform and Anti-Predatory Lending Act, 15 U.S.C. Sec. 1639 et seq.) overlaps the SAFE Act in regulatory intent and effect. It requires that a seller-lender in a residential seller-financed transaction (including wraps) determine at the time credit is extended that the buyer-borrower has the ability to repay the loan (the ATR rule). The ATR rule obligates the seller to investigate the buyer-borrower’s credit history, current and expected income, financial obligations, debt-to-income ratio, employment status, and the like in order to make a determination that a buyer-borrower has the reasonable ability to repay.

Dodd-Frank provides for a de minimis exception for persons doing no more than three owner-financed transactions per year (so long as the seller-lender is not in the building business)—but (1) the seller must take thorough steps to determine that the buyer has a reasonable ability to repay; and (2) the note must have a fixed rate or, if adjustable, may adjust only after five or more years and be subject to reasonable annual and lifetime caps. CFPB Reg. Sec. 1026.36(a)(4). In its comments to the rule, CFPB states that “A person in good faith determines that the consumer to whom the person extends seller financing has a reasonable ability to repay the obligation if the person complies with Sec.1026.43(c) [by considering] evidence of the [buyer-borrower’s] current or reasonably expected income.” Evidence of compliance with the ATR rule should always be retained in the seller’s file as a defensive measure against potential future lawsuits.

Dodd-Frank is a hugely complex law and continues to undergo interpretation and rule-making by the Consumer Financial Protection Bureau (CFPB). These rules are a challenge to understand, interpret, and apply—even for experienced attorneys who focus in this area.

The Future of Wraparounds

The general tendency of administrative agencies to take the rulemaking ball and run with it by producing a plethora of regulations is well established at both the state and federal levels (The federal Consumer Financial Protection Bureau is a prime example). The extensive Finance Code provisions discussed above are subject to rulemaking authority by the Department of Savings and Mortgage Lending under the jurisdiction of the Finance Commission. It is reasonable to expect that these regulations will expand.

Wrap transactions may still be done in Texas after the 2022 law changes, but carefully and with attention to both the statute and the rules designed to enforce it. More such rules will inevitably be released in the years to come, making this a challenging area for all involved—whether they be real estate investors. lenders, title companies, or attorneys.

In many ways, regulation of wraparounds is reminiscent of the approach the legislature took in cracking down on executory contracts in 2005. The net effect of that legislation was to drastically reduce the number of contracts for deed and substantially increase the risk for everyone involved in them.

The same forces are now in effect when it comes to wraparounds. This should not necessarily be viewed as a negative development. As was the case with executory contracts, the world of wraparounds has historically been full of abuse due to a fundamental power imbalance between seller and buyer. Statutory changes have been made in an attempt to redress that inequity. The degree to which they are effective in doing so without eliminating wraparounds entirely remains to be seen.


Information in this article is provided for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. This firm does not represent you unless and until it is expressly retained in writing to do so.

Copyright © 2024 by David J. Willis Attorney. All rights reserved worldwide. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, www.LoneStarLandLaw.com.