First, I want to clearly state that I am not providing insurance or legal advice. I am only providing information to help you make your own decisions.
Wrap around mortgages are a great way of financing real estate investments in today’s market. However, insuring a property purchased this way is often the biggest obstacle to making the deal happen.
The Insurance Problem With Wrap Around Mortgages
The complication is a new policy naming the buyer as the insured must be provided to the lender to verify the insurance is paid current and in compliance with that clause of the existing mortgage. The risk involved is that the lender notices the change in ownership and executes the “due on sale” clause of the contract.
Some people attempt to skirt this issue by having the previous owner remain on the insurance policy with an agreement they will file a claim on behalf of the new owner if it ever becomes necessary. There are several problems with this approach. At best, it’s a gray area if an insurance company is ever asked to pay a claim for a property no longer owned by the insured. There’s not enough room to list all of the potential pitfalls here but another possibility is the previous owner can’t even be found when a claim needs to be filed. Or they simply refuse to file or worse yet, they file the claim and keep the money.
Clearly that is not an option you want to use. There are really only two reasonable options.
Your Options for Insuring a Wrap
The first is based on the Garn–St. Germain Depository Institutions Act of 1982. This is the congressional act enabling widespread use of the due on sale clause. It specifies several conditions when the due on sale clause cannot be applied. One is when the property ownership is transferred into a living will and the beneficiary of the will is the original owner. Mortgage companies often see this because it’s a common estate-planning tool.
The way to structure it is for the seller to grant the title to the trust with themselves as the beneficiary and the buyer as the trustee. As the trustee, you hold title in the name of the trust for the benefit of the grantor. The buyer is now able to have insurance issued in their name for the benefit of the trust.
The mortgage company has no reason to assume the ownership of the house has changed. With this accomplished, the seller next assigns his or her beneficiary interest to the buyer. Nothing is recorded in public records so the lender never needs to know ownership has changed hands.
The buyer now has title to the property in their name for the benefit of the trust and is effectively the beneficiary of the trust. In this arrangement, the new owner can continuously pay the insurance premium and provide proof to the lender. What the lender sees is the property titled to the trust originally set up by the seller.
The other way of having insurance in the name of the buyer is completely straightforward. At closing, have the seller cancel their policy and have a new one issued in the name of the buyer. The buyer (or escrow) provides proof of insurance to the lender. You wait to see if the lender notices the change in ownership and if they do, if they activate the due on sale clause.
It’s not against the law to do a “subject to existing financing” sale. It’s the lender’s option whether to call the loan due. If you ask any real estate expert how many times they’ve seen a performing loan called due, the likely answer is never. In today’s real estate market where lenders have millions of loans in default, it makes no business sense at all to call due a loan that is being paid on schedule.
Author bio: Brian Kline has been investing in real estate for more than 30 years and writing about real estate investing for seven years. He also draws upon 25 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest in the Olympic Mountains with the Pacific Ocean a couple of miles in the opposite direction.