What if Residential Seller Files BK After I Wrap Sellers Loan?

Question

I'm researching doing a wraparound deal in TX. I don't have a lawyer yet, but I already have two pages of questions before wading into something that is new, risky, and unknown territory for me. The question that just popped into my head as I'm calling it a night is: "what happens to my seller's first mortgage if my seller files for bankruptcy at some point in the future after our transaction and before the first mortgage has been paid off?"

I will hire a TX based real estate law firm before spending much more time on this, but I'm curious if anyone has experience with a seller who has gone into bankruptcy after you wrapped their loan in TX or any other state.

Aaron Gordy · Answer

Hire an attorney that is experienced in wraps. There are a number of experienced attorneys in Texas that can do the wrap to cover yourself.  Imo, if there is a bit of risk on a deal then the price should reflect it. Seller finance is a great alternative for both the buyer and the seller on some deals. I have done this type of deal many times.

Greg H. · Answer

@Sean Bramble

That is not correct.  If that were the case then anyone facing foreclosure could just deed their property in order to avoid

The previous owner/seller/original mortgagee would have to reaffirm that debt in bankruptcy court which is not an absolute.  This is a risk to the buyer of a wrap

Greg H. · Answer

Wraps will always come with additional risk as there is another party involved besides the lender.  Saying that I have bought and sold via a wrap several times over the years. Some of the additional risks are:

-Due on sale clause.  The risk is very low that a lender will call the note but it has happened

-Bankruptcy- No document you sign or the seller/lender signs avoids the loan being included in the bankruptcy although as I stated previously the debt can be reaffirmed

-Keep in mind any escrow overage will be returned in the original borrowers name.  Additionally, on a conventional loan dropping PMI can be an issue as title will be in one name and the borrow another

Always insist that you make the payments directly with both you and the original borrower having portal access with the lenders online account

The Title Company- Wally Tingley in Austin has done these since the early 90's and has a conference with the buyer and seller to help make both parties comfortable

Chris Seveney · Answer

@Hind R.

There are two types of bankruptcies, Ch13 and ch 7

Ch 13 is a restructuring of debt. So if the loan was behind or if they had other unsecured debt they could file to get back on track. What could happen is the lender sees the deed was transferred then accelerate the debt so the entire loan would need to be paid during the BK

They file ch 7 it is to liquidate the debt (such as high medical bills) and when they file what to do with the home. They would be asked to reaffirm the debt or turn it over to the lender

Again since they already deeded the property of the did not reaffirm the debt the lender would go to foreclose and you would have to pay off the debt at that time. If the borrower attempted to reaffirm the debt the lender would most likely realize the property was deeded and call the loan anyways.

There are many paths this could go down.

Sean Bramble · Answer

If the deed is in your name you won’t lose the home, but if it stays in the sellers’s name you could lose it (plus any money you paid the seller along the way)

Hind R. · Answer

@Caroline Gerardo Thanks for your frank input.

Caroline Gerardo · Answer

You need to be ready with high FICO, IRS taxes showing enough net income, whatever down payment needed to refinance at any given day in the future. If you used the wrap because you cannot get traditional financing then you could lose everything, bank wins.

If seller files BK the loan is listed in the docket summary and lender gets notice in days. Servicer sees this file gets sold off to the rough and tumble servicer. They send people out to inspect and record who is in the house. Many digital tools tell the story in hours. Forced place insurance, property tax audit, legal fees all get added on to the loan in days. They call the loan. It doesn't matter what BK Chapter filing the seller does- notice happens, sets in motion to be on alert to foreclose. If you can quickly get a loan to pay it off you find the payoff amount much higher than you imagined.

You are not a creditor in bankruptcy court, you won't have much say in any decisions. The court generally forces that no payments can be made and fees pile up like ants.

Other scenarios to worry over:

House has a fire and check is issued joint to lender, how do you handle the process with adjuster?

Seller dies and lender gets notice. and so on...

@Hind R. no that scam doesn't save anything

Hind R. · Answer

@Greg H. Thanks!

Does utilizing a land trust for each property help minimize the risk of an institutional lender executing a "due on sale" clause? Technically the property is in a trust and the trust has been sold not the property. Or is this strategy just nonsense shared by the online real estate "guru's".

Hind R. · Answer

@Aaron Gordy @Eliott Elias and others thanks for the input. Can you recommend law firms here or via DM? Clearly an attorney in TX experienced with these types of transactions is critical to their success.

Also have you found any good software to manage all the moving parts of this type of transaction or are you just using excel to analyze the numbers? I'm fine with excel just wondering if there is something better out there especially if I develop a repeatable strategy and do multiple of these deals in TX. I haven't found any software online other that excel templates created by others that don't work.

Finally, so you all know, I'm not stuck in analysis paralysis. I just think it's prudent to try to think thru all the positive and negative paths/outcomes of a unique financial strategy before executing it. I also believe it's important to be in control of as much of the situation as possible. I don't want anyone else (including a bankruptcy court) to have leverage to tell me what I have to do or unwind my transaction or ruin it's economics.

Eliott Elias · Answer

Get with Ceshker title in Austin on this. They do all my creative finance deals

What if Residential Seller Files BK After I Wrap Sellers Loan?

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