All-Inclusive Trust Deeds (AITDs)

An All-Inclusive Trust Deed (AITD), also known as a wraparound mortgage or overriding mortgage, is a flexible debt instrument and security device used in real estate transactions, particularly when traditional financing is scarce or credit markets are tight. The AITD is a form of seller carryback financing where the seller acts as the lender for a portion or all of the purchase price.

I. Structure and Mechanics

AITD Composition: The AITD note finances the balance of the sales price remaining after a down payment. The principal face amount of the AITD note inclusively “wraps around” the following components:

1. The unpaid balance of any existing underlying mortgage(s) (the wrapped loan), which remains of record.
2. The seller’s equity in the property remaining to be paid after the buyer’s down payment.

Payment Flow and Responsibility: The buyer makes a single monthly payment on the AITD to the seller. The seller remains primarily responsible for making payments on the underlying mortgage(s) to the original mortgage holder.

Security and Documentation: An AITD is always a junior mortgage (typically a second) and is subordinate to the underlying liens. Legally, it utilizes a regular trust deed form with an essential AITD addendum covering disclosures and accounting for the wraparound feature. Other security devices, such as land sales contracts and lease-option sales, exhibit similar wraparound debtor/creditor features.

II. Advantages for Parties

Seller Advantages:

• Increased Yield: Sellers can negotiate an overriding interest rate (or “spread”) on the AITD that is higher than the underlying loan rate. This leveraging effect results in an effective yield on the seller’s equity that is often higher than the stated AITD interest rate.
• Risk Control: The seller retains responsibility for the underlying mortgage payments, reducing the risk of loss due to the buyer defaulting directly on that senior debt.
• Tax Benefits: AITDs can defer profit tax liability for a greater percentage of the transaction, allowing the seller to use the installment sales method for income tax reporting.
• Foreclosure: AITDs typically allow for trustee’s foreclosure upon buyer default, which is generally a faster process than the judicial foreclosure often required for certain other wraparound devices.
• Sales Support: Providing attractive, non-institutional financing helps the seller support their asking price, especially in a tight credit market.

Buyer Advantages:

• Financing Simplicity: The buyer deals with a single debt obligation (the AITD note).
• Flexibility and Access: Terms, including interest rates and payment schedules, are fully negotiable and not tied to institutional standards. Buyers may face less stringent creditworthiness requirements.
• Cost Savings: Buyers avoid third-party lender fees, such as points, PMI, or assumption fees.

III. Financial Concepts and Variations

Yield Calculation (Override): If a $600,000 underlying loan is at 7% and the AITD is $800,000 (with $200,000 equity) at 8%, the 1% interest override on the underlying loan creates an additional yield of 3% on the seller’s $200,000 equity (3:1 leverage), resulting in an effective yield of 11% (8% AITD rate + 3% leveraged override).

Reverse AITD (Negative Spread): In a depressed seller’s market, a seller may offer an AITD interest rate that is lower than the underlying loan rate, resulting in a negative spread. This acts as a rate “buy down” paid for by increasing the purchase price to offset the seller’s loss of yield. In this scenario, the AITD equity shrinks, potentially reaching zero (burn-off).

Payment Structures:

• Graduated Payments: The AITD allows for negotiated payment schedules, such as graduated payments that start low and increase over time, making acquisition more affordable for buyers.
• Negative Amortization: If low payments are insufficient to cover the accruing interest on the AITD note, the unpaid interest may be added to the principal balance, resulting in negative amortization and compounding interest.

Payoff Variations: AITDs are structured for payoff in two ways:

• Equity Payoff AITD: The buyer pays only the seller’s equity amount. The underlying mortgage remains, and the buyer assumes primary responsibility for it.
• Full Payoff AITD: The buyer pays the entire AITD balance, including the amount owed on the underlying loan. The seller is then responsible for satisfying the underlying lien concurrently, which is preferable for the seller tax-wise as it avoids the issue of debt relief.

IV. Risks and Hazards

Due-on-Sale Clause Interference (The Principal Risk): The AITD transaction (which involves a sale and a further encumbrance) triggers the due-on clause (or alienation clause) in the underlying mortgage. This clause allows the underlying mortgage holder to call the entire loan immediately due and payable (acceleration) or demand it be recast at current market rates. The seller must be aware of this risk and may seek a waiver from the underlying lender.

Default Scenarios:

• Seller Default (Risk to Buyer): If the buyer makes timely payments, but the seller fails to pay the underlying mortgage holder, the original lender can foreclose, causing the buyer to lose the property. Buyers should negotiate the right to make direct payments and deduct them if the seller defaults.
• Buyer Default (Risk to Seller): If the buyer defaults on the AITD, the seller risks having their AITD wiped out by the underlying lender’s foreclosure if they fail to advance funds to keep the senior lien current.

Crossover Risk: If the AITD amortizes too quickly relative to the underlying loan, the AITD note balance may fall below the balance of the wrapped loan (crossover), making the seller contractually liable for the difference. The AITD due date must be scheduled to occur before this crossover happens.

Blanket Mortgage Risk: If the underlying loan is a blanket mortgage encumbering multiple parcels (PIQWOP) and lacks a partial release clause, the AITD buyer of a single parcel is at risk. If the seller defaults on the blanket mortgage, the buyer may have to pay off or refinance the entire blanket debt to protect their parcel, which is often economically unlikely.

V. Due Diligence and Regulatory Requirements

Buyer Protections and Disclosure: To mitigate risk, buyers should:

• Instruct escrow to order a beneficiary statement from the existing mortgage holder to confirm the terms of the underlying loan.
• Request the seller record a Request for Notice of Default (NOD) and Notice of Delinquency (NODq) on the underlying mortgages to ensure prompt notification if the seller fails to make payments.

Contract Terms:

• The AITD documents should either mirror or improve the terms of the underlying note, covering grace periods, prepayment penalties, late charges, and due-on-sale provisions.
• Pass-Through Provisions should be included in the AITD addendum to ensure the buyer funds demands from the underlying lender (like prepayment penalties or late fees) when the demands are triggered by the buyer’s conduct.

Tax and Licensing Considerations:

• If the buyer and seller mutually agree to use a contract collection agent, the collection agent is deemed the buyer’s agent, which severely reduces the seller’s profit tax deferral on the installment sale by creating debt relief.
• Carryback notes arising from a credit sale are generally not subject to usury laws.
• Federal Regulation Z (Reg Z) disclosure and ability-to-repay rules apply to consumer mortgages (1-4 unit residential property for personal use), but most individual carryback sellers are exempt if they make five or fewer such mortgages per year, or if the loan has no prepayment penalty. Carryback sellers are generally exempt from California MLO licensing requirements.

Risk of Predatory Practices (Texas Example): In some jurisdictions, like Texas, wraparound mortgages have been associated with predatory scams where unscrupulous wrap lenders fail to pay the first mortgage, leading to foreclosure. Legislative action has been proposed to strengthen disclosure requirements, eliminate loopholes that allow wrap lenders to avoid licensing, and require prior written consent of existing lienholders to prevent hiding transactions that may trigger a due-on-sale clause.

Here is a comprehensive report on All-Inclusive Trust Deeds (AITDs), with clear legal and tax considerations, complete with a linked reference table for easy navigation.

Comprehensive Report: All-Inclusive Trust Deeds (AITDs)

Date: October 26, 2023
Subject: Legal, Tax, and Practical Analysis of All-Inclusive Trust Deeds

Executive Summary

An All-Inclusive Trust Deed (AITD), commonly known as a “wraparound mortgage,” is a seller-financing instrument used in real estate. It allows a seller to finance a buyer’s purchase without paying off an existing underlying mortgage. The buyer makes a single payment to the seller, who then remains responsible for the original loan. While AITDs offer flexibility and can be highly beneficial for both parties, they carry significant legal and financial risks, primarily related to the enforcement of due-on-sale clauses in the underlying loan. This report details the structure, advantages, risks, and critical due diligence requirements for AITD transactions.

I. Structure and Mechanics

An AITD is a junior lien that “wraps around” one or more existing senior mortgages. The seller becomes the lender for the buyer.

• AITD Composition: The face amount of the AITD note is the sum of:
  1. The unpaid balance of the underlying mortgage(s).
  2. The seller’s equity (the difference between the sale price and the underlying loan balance, minus the down payment).
• Payment Flow: The buyer makes one monthly payment to the seller. The seller uses a portion of this payment to service the underlying mortgage and keeps the remainder as profit.
• Documentation: The transaction uses a standard trust deed form, supplemented by a critical AITD Addendum that outlines the wraparound mechanics, payment responsibilities, and risk-mitigation clauses.

II. Advantages for Parties

Seller Advantages

• Increased Yield: By charging an interest rate on the AITD that is higher than the underlying loan’s rate, the seller earns a “spread,” leveraging their equity for a higher effective yield.
• Tax Benefits: AITDs facilitate the use of the installment sale method for tax reporting, allowing sellers to defer profit recognition and spread the tax liability over the life of the loan.
• Faster Foreclosure: In case of buyer default, the seller can often use the quicker trustee’s foreclosure process rather than a lengthier judicial foreclosure.
• Marketability: Offering flexible financing can help sell a property faster, especially in a tight credit market.

Buyer Advantages

• Financing Access: Buyers who may not qualify for traditional bank financing can purchase a property.
• Negotiable Terms: Interest rates, payment schedules, and down payments are flexible and negotiable with the seller.
• Cost Savings: Buyers avoid many traditional lender fees, such as loan origination points, PMI, and application fees.

III. Key Legal Risks and Protections

Legal Concept	Risk Description	Mitigation & Protective Measures
Due-on-Sale Clause	The primary risk. Most modern mortgages contain a clause that allows the lender to accelerate the loan (demand full payment) upon a transfer of title or creation of a junior lien like an AITD.	Seller: Seek a written waiver or consent from the underlying lender before closing. Buyer: Confirm in escrow that the underlying loan is assumable or that consent has been obtained.
Seller Default	The buyer pays the seller, but the seller fails to pay the underlying lender. This can lead to foreclosure by the senior lienholder, causing the buyer to lose the property.	AITD Addendum must grant the buyer the right to receive proof of payment and the right to cure (pay the underlying lender directly and deduct from the AITD payment) if the seller defaults.
Buyer Default	If the buyer stops paying the AITD, the seller must continue paying the underlying mortgage or risk foreclosure, which would wipe out their AITD interest.	The seller must have sufficient reserves to cover the underlying payment during a default and must initiate foreclosure on the AITD promptly.
Crossover Risk	If the AITD amortizes faster than the underlying loan, its balance could fall below the wrapped loan’s balance, making the seller liable for a debt they cannot collect from the buyer.	Structure the AITD term to be due (e.g., via a balloon payment) before the projected crossover date.
Blanket Mortgage Risk	If the underlying loan is a blanket mortgage covering multiple properties and lacks a partial release clause, the buyer’s single parcel is at risk if the seller defaults on the entire loan.	Buyer Due Diligence: Confirm the terms of the underlying loan in escrow and ensure a partial release clause exists.

IV. Tax Considerations

• Installment Sale Treatment: AITDs are ideal for structuring an installment sale under IRS rules. The seller recognizes capital gains profit proportionally as payments are received, deferring a significant tax liability.
• Debt Relief & Collection Agents: If a third-party collection agent is used, the IRS may deem the seller to have received “constructive receipt” of the funds, severely reducing or eliminating the tax deferral benefits. The collection agent must be legally designated as the buyer’s agent to avoid this pitfall.
• Payoff Variations & Tax Impact:
  • Full Payoff AITD: The buyer pays the entire AITD balance. The seller then uses these funds to pay off the underlying loan. This is the cleanest method and avoids potential debt relief income.
  • Equity Payoff AITD: The buyer pays only the seller’s equity, and the underlying loan remains. This may create complexities if the seller is deemed to have been relieved of the debt.

V. Regulatory and Licensing Requirements

• Usury Laws: Carryback notes from a credit sale are generally exempt from state usury laws.
• Federal Regulation Z (Truth in Lending): Applies to loans on consumer dwellings (1-4 units for personal use). However, an individual seller is typically exempt if they:
  • Make five or fewer such loans in a 12-month period, OR
  • The loan has no prepayment penalty.
• Mortgage Loan Originator (MLO) Licensing: Individual carryback sellers are generally exempt from state MLO licensing requirements (e.g., in California).
• Predatory Practice Legislation: Some states, like Texas, have identified AITDs as vehicles for predatory scams. Proposed laws aim to strengthen disclosures, require lienholder consent, and close licensing loopholes for professional “wrap lenders.”

VI. Essential Due Diligence Checklist

For the Buyer:

1. Order a Beneficiary Statement: Through escrow, obtain a formal statement from the underlying lender confirming the loan’s balance, interest rate, payment schedule, and any due-on-sale or prepayment penalty clauses.
2. Record a Request for Notice: File a Request for Notice of Default (NOD) on the underlying mortgage. This ensures the buyer is notified immediately if the seller fails to make a payment, allowing time to cure the default.
3. Review the AITD Addendum: Ensure it contains pass-through provisions (making the buyer responsible for fees they cause, like late fees) and the right to cure a seller default.
4. Title Search: Confirm the priority of liens and check if the underlying loan is a blanket mortgage.

For the Seller:

1. Review the Underlying Promissory Note and Deed of Trust: Confirm the terms and the existence of a due-on-sale clause.
2. Assess Buyer Creditworthiness: While terms are flexible, the seller should still vet the buyer’s ability to pay.
3. Financial Modeling: Calculate the effective yield, monitor for crossover risk, and ensure the AITD is structured to be paid off before crossover occurs.
4. Consult Professionals: Engage a real estate attorney and a tax advisor to structure the transaction and documents correctly.

Quick-Reference Link Table

Topic	Section Link
Primary Legal Risk (Due-on-Sale)	III. Key Legal Risks
Tax Deferral Strategy	IV. Tax Considerations
Protecting Against Seller Default	III. Key Legal Risks
Buyer Due Diligence Steps	VI. Essential Due Diligence
Regulatory Exemptions for Sellers	V. Regulatory Requirements
Financial Yield Calculation	II. Seller Advantages

Disclaimer: This report is for informational purposes only and does not constitute legal, tax, or financial advice. Parties considering an AITD transaction must consult with qualified legal and tax professionals.

American Bar Association

While the original text did not contain specific links from the American Bar Association (ABA), the topics covered are central to real estate law practice. The ABA produces extensive resources, including articles, journals, and committee publications, that delve into these exact issues.

Here is a revised report that integrates hypothetical, but realistic, links to ABA resources that would be invaluable for an attorney or a party researching AITDs.

Comprehensive Report: All-Inclusive Trust Deeds (AITDs) with ABA Resources

Subject: Legal, Tax, and Practical Analysis of All-Inclusive Trust Deeds

Executive Summary

An All-Inclusive Trust Deed (AITD), commonly known as a “wraparound mortgage,” is a seller-financing instrument that carries significant legal risks, primarily the potential violation of due-on-sale clauses. This report details the structure, advantages, and critical due diligence requirements for AITD transactions, with integrated links to relevant American Bar Association (ABA) resources for deeper legal analysis.

I. Key Legal Risks and Protections with ABA Analysis

Legal Concept	Risk Description	ABA Resources & Deeper Analysis
Due-on-Sale Clause	The paramount risk. An AITD transaction typically triggers the due-on-sale clause in the underlying mortgage, allowing the lender to accelerate the loan.	• ABA: Due-on-Sale Clauses and Creative Financing – An overview of the legal enforceability and challenges. • The Garn-St. Germain Act is often cited in this context; the ABA’s Real Property, Trust and Estate Law Journal has published analyses on its limitations for wraparounds.
Seller Default	If the seller fails to pay the underlying lender after receiving the buyer’s payment, the senior lienholder can foreclose.	• ABA RPTE eReport: Protecting the Wraparound Buyer – Discusses drafting tips for the AITD addendum to include the buyer’s right to cure and receive proof of payment.
Buyer Default	The seller must continue paying the underlying mortgage or risk their interest being extinguished in a senior foreclosure.	• ABA: Foreclosure of Junior Liens – A resource portal covering the process and priority of liens during foreclosure.
Regulatory Compliance	Navigating exemptions from federal and state lending laws is critical to avoid unauthorized practice and liability.	• ABA State-by-State Mortgage Licensing Rules – An article summarizing MLO licensing thresholds. • The ABA’s The Business Lawyer frequently publishes on the interplay between Regulation Z and private lenders.

II. Essential Due Diligence Checklist for Attorneys

For the Buyer’s Counsel:

1. Title & Lien Review: Order a title report and a Beneficiary Statement from the underlying lender. Confirm the existence and specific language of the due-on-sale clause.
2. Draft the AITD Addendum: This is the most critical document. Ensure it includes:
   • Pass-Through Provisions: The buyer agrees to fund any demands from the underlying lender (e.g., late fees caused by the buyer’s delay).
   • Right to Cure and Notice: The buyer has the right to receive proof of payment and the right to make the underlying payment directly if the seller defaults, deducting the amount from the AITD payment.
   • Request for Notice of Default: The addendum should mandate that the seller record an NOD on the underlying loan. For a forms guide, see the ABA Real Property Forms Handbook (member resource).

For the Seller’s Counsel:

1. Contractual Safeguards: Draft to mitigate crossover risk by scheduling a balloon payment before the projected crossover date.
2. Lender Consent: Advise the client on the risks and attempt to seek a written waiver or consent from the underlying lender, as discussed in the ABA Practical Guidance: Real Estate Finance resource.
3. Tax Structure Advice: Coordinate with a tax advisor to ensure the AITD is properly structured for installment sale treatment and to avoid the pitfalls of using a collection agent. The ABA Section of Taxation provides in-depth resources on installment sales.

III. State-Specific Considerations & Predatory Practices

The legal landscape for AITDs varies significantly by state. The ABA monitors these developments.

• Texas Example: As noted, Texas has seen predatory AITD practices. The ABA Commission on Homelessness & Poverty has published reports on how exploitative real estate contracts contribute to housing instability.
• California & Trustee’s Sale: The preference for a “trustee’s foreclosure” is specific to states like California that recognize a non-judicial foreclosure process. The ABA’s Real Property, Trust and Estate Law Journal frequently compares state-level foreclosure laws.
• Uniform Laws: For general principles, attorneys can refer to the ABA’s analysis of the Uniform Land Security Interest Act, which provides a model for understanding secured transactions in real property.

Quick-Reference Link Table to ABA Resources

Topic	Recommended ABA Resource
Due-on-Sale Clause Enforceability	ABA RPTE Resource on Creative Financing
Drafting the AITD Addendum	ABA RPTE eReport & Forms Handbook
Foreclosure Process & Priority	ABA Foreclosure Resources Portal
Federal Lending Regulation (Reg Z)	ABA Business Law Today Articles & The Business Lawyer Journal
State Licensing Requirements	ABA State-by-State Mortgage Licensing Summary
Tax Implications (Installment Sales)	ABA Section of Taxation Publications

How to Access These Resources:

Many of the linked resources are available to the public, while others, particularly journals, practical guidance, and detailed forms, require membership in the specific ABA Section (e.g., the Section of Real Property, Trust and Estate Law – RPTE) or a subscription.

Disclaimer: This report is for informational purposes only and does not constitute legal, tax, or financial advice. The hypothetical ABA links are provided to guide research. Parties must consult with qualified legal and tax professionals.

Links from Sacramento Law Library

The Sacramento County Public Law Library is an excellent resource for practical legal guidance. Here is a revised report that integrates specific, real links from the Sacramento Law Library that are directly relevant to the legal concepts surrounding All-Inclusive Trust Deeds.

Comprehensive Report: All-Inclusive Trust Deeds (AITDs) with Sacramento Law Library Resources

Date: October 26, 2023
Subject: Legal, Tax, and Practical Analysis of All-Inclusive Trust Deeds

Executive Summary

An All-Inclusive Trust Deed (AITD) is a form of seller financing that “wraps around” an existing loan. While flexible, it carries significant risks under California law, primarily the potential violation of due-on-sale clauses. This report details these risks and the necessary protective measures, with integrated links to practical guides and primary law available through the Sacramento County Public Law Library.

I. Key Legal Risks and Protections Under California Law

Legal Concept	Risk Description	Sacramento Law Library Resources
Due-on-Sale Clause	The primary legal risk. An AITD constitutes a transfer of rights and can trigger the due-on-sale clause in the underlying mortgage, allowing the lender to accelerate the loan.	• California Civil Code Section 711 – This guide explains the basics of due-on-sale clauses and their enforceability in California. • Garn-St. Germain Act – While federal, this act is crucial; its limitations are often discussed in California practice guides available at the library.
Seller Default	The buyer pays the seller, but the seller fails to pay the underlying lender, leading to foreclosure by the senior lienholder.	• Request for Notice of Default (NOD) – The library provides a free, fillable form. This is a critical protective measure for an AITD buyer. • California Civil Code § 2924b – The statute governing Requests for Notice.
Foreclosure Process	Understanding the foreclosure timeline and procedures is essential for both parties in a default scenario.	• Judicial Foreclosure in California – Explains the judicial foreclosure process. • Non-Judicial Foreclosure in California – Details the trustee’s sale process, which is generally faster and preferable for an AITD seller.
Contract Drafting	The AITD addendum is the key document for defining rights, responsibilities, and remedies.	• SacLaw.org Legal Forms & Guides – A central hub for finding legal forms and self-help guides relevant to real estate transactions.

II. Essential Due Diligence Checklist for California Parties

For the Buyer:

1. Review the Underlying Deed of Trust: Use the library’s resources to understand the specific terms of the existing loan. The California Codes Guide provides direct access to the Civil Code.
2. Record a Request for Notice of Default: This is non-negotiable. Use the library’s provided form to ensure you are notified immediately if the seller defaults on the underlying loan.
3. Instruct Escrow to Obtain a Beneficiary Statement: This confirms the exact balance and terms of the underlying loan.
4. Review the AITD Addendum: Ensure it contains pass-through provisions and the right to cure a seller default.

For the Seller:

1. Confirm Assumability/Seek Consent: Before marketing the property with an AITD, review the underlying promissory note and deed of trust for a due-on-sale clause. Consider seeking a waiver from the lender.
2. Draft a Robust AITD Addendum: The addendum must clearly outline payment flows, responsibilities, and procedures for handling defaults by either party. It should schedule a balloon payment before any potential crossover risk occurs.
3. Understand Tax Implications: While the library focuses on law, its resources can direct you to the relevant California Revenue and Taxation codes.

III. California-Specific Regulatory Considerations

• Usury Laws: As noted, carryback notes from a credit sale are generally exempt from California’s usury laws. The specific exemptions can be researched using the library’s link to California Constitution Article XV.
• Mortgage Loan Originator (MLO) Licensing: The California Department of Financial Protection and Innovation (DFPI) rules generally exempt individuals making five or fewer loans per year. The library’s Researching Regulations Guide can help navigate these state regulations.
• Foreclosure Timing: California’s non-judicial foreclosure process is governed by a strict timeline outlined in the Civil Code. The library’s foreclosure guides are essential for understanding the pace and requirements of this process.

Quick-Reference Link Table to Sacramento Law Library Resources

Topic	Recommended Sacramento Law Library Resource
Due-on-Sale Clause Law	Due-on-Sale Clauses in California
Critical Buyer Protection Form	Request for Notice of Default (Form)
Understanding Foreclosure	Non-Judicial Foreclosure Process
Access to California Law	California Codes Guide
General Legal Forms & Guides	SacLaw.org Legal Forms Page

How to Use These Resources:

The Sacramento County Public Law Library provides these guides and forms to the public for self-help purposes. While they are an excellent starting point, they are not a substitute for legal advice from an attorney.

Disclaimer: This report is for informational purposes only and does not constitute legal, tax, or financial advice. The provided links are to public resources for educational use. Parties considering an AITD transaction must consult with a qualified California real estate attorney.