FAQ AITD All Inclusive Trust Deed

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FAQ on All-Inclusive Deeds of Trust (Wraparound Mortgages)

What is an All-Inclusive Deed of Trust (AITD) or Wraparound Mortgage? An All-Inclusive Deed of Trust (AITD), also known as a wraparound mortgage, is a financing tool used when a seller provides part of the financing for a buyer, while the property also remains subject to an existing mortgage. The seller continues to make payments on their original mortgage, and the buyer makes payments to the seller on the new “wraparound” loan which covers the existing mortgage and the additional financing provided by the seller. The seller essentially “wraps” the existing mortgage with the new loan to the buyer.
When is an AITD typically used? AITDs are commonly used in a few situations. First, when interest rates on existing loans are much lower than current prevailing rates. This allows the seller to charge a rate that is lower than current rates but still earns a “spread” (profit) between the rates. Second, when the existing loan has a very high rate, the buyer is able to secure a lower rate through the wraparound, while the seller continues to service the underlying loan. They are also used if the underlying loan has a substantial prepayment penalty or if the buyer cannot qualify for a loan for the full purchase amount.
How does an AITD benefit the buyer? The buyer may benefit from a lower overall price or a smaller down payment compared to standard financing. They can also avoid the fees and costs associated with obtaining a new institutional loan and might bypass the assumption fees if they were to take over the existing loan. Furthermore, if the seller’s existing loan has a high interest rate, the wrap around loan effectively allows the buyer to “buy down” the rate.
How does an AITD benefit the seller? The seller can facilitate a sale by providing financing, potentially reaching a wider pool of buyers. They can also earn a profit through the interest rate “spread” between the existing loan’s rate and the rate charged to the buyer on the wraparound note. This can be particularly lucrative when the underlying interest rate is significantly lower than the rate they charge on the AITD.
What is the “due on sale” clause and how does it relate to AITDs? A “due on sale” clause in a mortgage allows the lender to demand full repayment of the loan balance if the property is sold or transferred. Because AITDs involve a transfer of ownership, they technically trigger the clause, which allows the lender to call the underlying loan due. While the parties may hope the lender doesn’t find out about the transfer, lenders often monitor tax records and other sources to detect these types of changes.
What are some key considerations that need to be negotiated in an AITD agreement? Several key terms should be addressed in the AITD agreement: restrictions on the seller’s right to refinance the underlying loan; the seller’s obligations in the event of acceleration of the underlying note; whether the buyer should pay a collection agent to make sure the underlying loan gets paid; how long the seller collects the interest rate spread; the buyer’s right to pay the underlying note directly if the seller doesn’t; how the seller can recover their costs if they need to make payments on the underlying note on the buyer’s behalf; default procedures for both the buyer’s note and the underlying note; and prepayment penalties, which should mirror the terms of the underlying loan.
What terms in the underlying note should the AITD mirror? The AITD should generally mirror or better the terms in the underlying note. These include: grace periods; due-on-sale (acceleration) provisions; the timing of payments and late charges; prepayment restrictions and penalties; tax and insurance impounds; insurance requirements and premiums; and rights related to leasing, condemnation, repair, and construction.
Why is it important to consult with a real estate attorney when using an AITD? Given the complexity of AITD transactions, it is crucial for both buyers and sellers to consult with an experienced real estate attorney. The attorney will ensure that the AITD documents are drafted with sufficient protections for their interests. They can also navigate potential issues related to the underlying loan and compliance with real estate regulations, particularly regarding issues surrounding the due-on-sale clause and lender notification.

AITD Briefing

Here’s a detailed briefing summarizing the key themes and ideas from the provided blog posts about All-Inclusive Deeds of Trust (AITDs) in California:

Briefing Document: All-Inclusive Deeds of Trust (Wraparound Mortgages) in California

Introduction

This briefing document analyzes two blog posts from the Law Office of James J. Falcone, focusing on All-Inclusive Deeds of Trust (AITDs), also known as wraparound mortgages, in the context of California real estate. These posts discuss when and why AITDs are used, their benefits and risks, and key terms that should be addressed when drafting these agreements. The author suggests AITDs may become popular again due to rising interest rates.

What is an All-Inclusive Deed of Trust (AITD)?

Definition: An AITD is a financing mechanism where the seller of a property finances a portion of the sale price while the buyer also takes on the existing loan secured by an underlying deed of trust.
Mechanism: The seller remains responsible for making payments on the existing (“underlying”) loan, while the buyer makes payments to the seller on a new, encompassing (“overriding”) note secured by the AITD. The seller effectively “wraps” the existing loan with the new loan.
As the author explains,

“The seller remains on the existing loan (and continues to make the payments) and finances the difference between the existing loan balance and the purchase price.”

Key Parties:Seller: Owns the property, pays the underlying note, and receives payments from the buyer on the overriding note.
Buyer: Pays the overriding note to the seller, taking subject to the underlying loan.

Situations Where AITDs Are Used

Two primary scenarios where AITDs are employed:

Lower Existing Interest Rate:

When the existing loan’s interest rate is significantly lower than the prevailing market rate, the seller can offer a rate that is lower than the market, but still higher than their rate. This “spread” allows the seller to profit from the difference.

“When the interest rate on the existing loan is much lower then the current prevailing rate, the rate of the wraparound can be lower then the [prevailing rate, and the seller still earns a spread between the rate he is paying and the rate that the buyer is paying to the seller.”

Higher Existing Interest Rate: Conversely, if the existing loan has a substantially higher interest rate than the current market, the buyer can “buy-down” the effective rate by making payments on a new loan with a rate closer to the current one. * “When the interest rate on the existing loan is substantially higher than the current rate, the buyer is able to ‘buy-down’ the high rate by paying a rate closer to the prevailing rate. This situation may be less lucrative for the seller, as he still must pay the higher rate on the existing loan.”

Additional Reasons for Use: AITDs are also used when:

The underlying loan cannot be prepaid without substantial penalty.
The buyer does not qualify for a traditional loan for the full purchase price.

Advantages of AITDs

For Buyers: Potentially lower purchase price and down payment.
- Avoidance of fees and costs associated with traditional institutional loans or assumption fees.
- Possible access to financing when unable to qualify for traditional loans.
For Sellers:
- Opportunity to earn interest on the difference between the buyer’s payment and the underlying loan.
- Facilitates a sale when traditional financing is difficult for buyers.

Risks and Considerations

- Due-on-Sale Clause: A significant risk for both parties is the potential enforcement of the due-on-sale clause in the underlying loan. The transfer of title to the buyer could trigger the lender to demand immediate payment of the entire loan balance.

“Another possible, but inappropriate advantage to both parties, is the possibility of avoiding the due on sale clause in the underlying loan.”

Seller’s Obligation: The seller is obligated to continue making payments on the underlying loan.
“The seller holds payments from the buyer as a fiduciary and is obligated to make the payments on the underlying loan.”
Potential for Default: The AITD must address default scenarios of both seller and buyer:
Seller Default: The AITD should specify if the buyer can make payments directly on the underlying loan if the seller does not and deduct these payments from the amount owed to the seller.
Buyer Default: The AITD should detail what happens if the buyer defaults and if the seller can add any advanced payments to the outstanding debt of the buyer.
Refinancing Restrictions: The AITD may need to restrict the seller’s ability to refinance the underlying loan.

Key Terms to Negotiate in the AITD

The second blog post emphasizes several crucial terms to include in the AITD to protect all parties:

Seller’s Obligations: What is the seller’s obligation if the underlying loan accelerates (due to transfer or default)?
Collection Agent: Should a collection agent be used to ensure the underlying loan is paid?
Spread after Seller Equity Paid Off: Will the seller continue to collect the spread after their equity is paid off?
Buyer’s Direct Payment Right: The buyer should have the right to pay the underlying loan directly if the seller does not.
Seller’s Advances: Can the seller add advanced funds to the AITD balance (plus interest) if they cover the underlying loan payments?
Default Terms: The AITD should define and address default scenarios, with specific steps that align with title company requirements.
Prepayment Penalties: The AITD should at least mirror any prepayment penalties present in the underlying note. The seller must address their potential loss of yield if the buyer prepays the seller’s equity early.
Reconveyance: What will trigger the reconveyance of the AITD?
Mirroring the Underlying Note: The AITD must mirror or improve the terms of the underlying loan:
Grace periods
Due-on-sale provisions
Payment timing and late charges
Prepayment penalties
Tax and insurance impounds
Insurance requirements
Rights regarding leasing, condemnation, repairs, and construction

Conclusion

The blog posts suggest that all-inclusive deeds of trust may become more common again due to economic conditions. However, they are complex financial instruments that require careful drafting and negotiation to protect both buyers and sellers. The author strongly recommends consulting with an experienced real estate attorney to ensure the proper creation of such documents.

Carryback financing, also known as seller financing, occurs when a seller provides a loan to the buyer to finance the purchase of the seller’s property [1]. This arrangement is also referred to as an installment sale, credit sale, or owner-will-carry (OWC) sale [1, 2]. Here’s a breakdown of key aspects of carryback financing, as described in the sources:

When is Carryback Financing Used?

Carryback financing is often considered when traditional mortgage money is scarce, and lenders become more selective [1, 3].
It can help a seller find a buyer willing to pay their asking price, especially when mortgage markets are tight [3].
It can be used to help buyers who are unable or unwilling to obtain sufficient funds from traditional lenders [4].

Benefits for Buyers

Moderate down payment:Carryback financing often allows for a smaller down payment, which is negotiated between the buyer and seller [5, 6].
Flexible terms:Buyers can sometimes negotiate lower-than-market interest rates in exchange for agreeing to a higher asking price [6].
Reduced closing costs:Buyers avoid some of the costs associated with traditional loans [7].

Benefits for Sellers

Higher Sales Price:Sellers can often achieve a higher sales price by offering carryback financing [3, 8].
Tax Benefits:Sellers can report profits from the sale over several years, rather than all in the year of the sale [2, 6, 9-12].
Interest Income:Sellers receive interest income on the carryback note [12, 13].
Potential for Higher Yields:Sellers can potentially earn a higher yield by structuring the note to their advantage [14].

Risks for Sellers

Buyer Default:The seller faces the risk of the buyer defaulting on the carryback note [11].
Foreclosure Costs:If the buyer defaults, the seller may need to foreclose and resell the property, incurring additional costs [11, 15, 16].
Nonrecourse Mortgage:A carryback note secured solely by a trust deed on the property sold is typically a nonrecourse mortgage, meaning the seller cannot obtain a money judgment against the buyer for any deficiency [17, 18].
Loss of Value:If the buyer neglects the property, its value may decrease, impacting the seller’s ability to recover the full amount owed [19, 20].
Subordination:If the carryback loan is subordinated to another mortgage or deed of trust, the seller accepts a greater risk of loss [21, 22].
Due-on-Sale Clause:If the underlying mortgage has a due-on-sale clause, the seller may need to obtain a waiver or consent from the lender [19, 23].

Types of Carryback Notes

Regular Note:A regular note is for the balance of the seller’s equity after deducting the buyer’s down payment [24, 25].
All-Inclusive Trust Deed (AITD):The AITD note covers the entire unpaid purchase price, including any existing mortgages [25-28]. The seller remains responsible for payments on the underlying mortgage [29-32].
Straight Note:A straight note calls for a single payment of principal and accrued interest at the end of the term [33].
Shared Appreciation Mortgage (SAM):A SAM involves a lower fixed interest rate and additional contingent interest based on the property’s appreciated value [34-36].

Key Provisions and Considerations

Down Payment:The amount of the down payment is negotiable between the buyer and seller [6]. A larger down payment reduces the risk of loss for the seller [16, 37].
Interest Rate:The interest rate on the carryback note may be lower than market rates but is usually structured to account for the seller’s risk [5, 6, 38].
Due Date:Carryback notes often include a final/balloon payment due at the end of a specified term [39-43].
Security:The carryback note is typically secured by a trust deed on the property [1, 44, 45]. Additional security or guarantees can be included, especially in no-down-payment situations [46, 47].
Creditworthiness:The seller needs to assess the buyer’s creditworthiness to determine their ability to repay the debt [9, 16, 48-51].
Disclosure:A Carryback Disclosure Statement is required in many situations, particularly for residential properties, to ensure both parties are aware of the risks [50, 52-56].
Subordination:The seller may agree to subordinate their carryback mortgage to another mortgage, which can increase the risk of loss [21, 22, 57-60].