PURCHASING MORTGAGED PROPERTY

Subject to the mortgage

Purchase money mortgage

Wraparounds

Assumptions

Contracts for deed

When a buyer pays cash for a property at closing, any existing mortgage on the property is paid off from the sale proceeds, and the  seller’s interests are transferred to the buyer.  The cash may be the entirely buyer’s, or some of it may be the proceeds of a new mortgage loan undertaken by the buyer. However, There are other ways for the buyer to purchase a mortgaged property, namely:

  • subject to the existing mortgage
  • with a wraparound  mortgage
  • by assumption of the existing mortgage
  • by contract for deed

Subject to the mortgage                     

In buying a property subject to the existing mortgage, the buyer takes title and makes loan payments to the mortgagee (lender), while the seller (original mortgagor) remains personally responsible for the loan payments. In the event that the buyer defaults, the lender can force a foreclosure sale and sue the seller (not the buyer) for any deficiency if the sale proceeds do not satisfy the debt.

Purchase money mortgages                   

With a purchase money mortgage, the borrower gives a mortgage and note to the seller to finance some or all of the purchase price of the property. The seller in this case is said to “take back” a note, or to “carry paper,” on the property. Purchase money mortgages may be either senior or junior liens.

Wraparounds              

In a wraparound loan arrangement, the seller receives a junior mortgage from the buyer, and uses the buyer’s payments to make the payments on the original first mortgage. A wraparound enables the buyer to obtain financing

with a minimum cash investment. It also potentially enables the seller to profit from any difference between a lower interest rate on the senior loan and a higher rate on the wraparound loan. A wraparound is possible only if the senior mortgagee allows it.

Assumptions              

With a mortgage assumption, the buyer acquires title to a mortgaged property and, signing a new promissory note with the lender, takes on personal responsibility for the terms and payments of the mortgage. The buyer is now primarily liable, but the original mortgagor remains secondarily liable under the original promissory note. Thus, if the buyer defaults, the lender can sue both the buyer and the seller for any deficiency in the proceeds of a foreclosure sale to satisfy the debt. A novation agreement, signed by seller, buyer, and lender, can relieve the seller of any further liability after the sale.

Contracts for deed     

As discussed in Section 11 under “Installment Sales Contracts,” a contract for deed (land contract, installment sale contract, conditional sales contract, agreement for deed) allows the buyer of a property to defer payment of some or all of the purchase price over a specified period. During the period, the seller holds legal titlewhile the buyer holds equitable title. The buyer takes possession of the property, makes payments of principal and interest to the seller, and maintains the property. At the end of the period, the buyer pays the seller the remainder of the full purchase price and the seller conveys legal title to the buyer.

A contract for deed serves several purposes for a seller. First, it facilitates a sale that might otherwise be impossible. Second, it may give the seller certain tax benefits. Since the seller is not liable for capital gains tax until the purchase price is received, the installment sale lowers the seller’s tax liability in the year of the sale. There may also be a reduction in closing costs. Disadvantages for the seller include: the buyer might create encumbrances during the contract or cause disputes and litigation over the contract;

For the buyer, the contract for deed makes possible a purchase where adequate credit and funds for a down payment and loan qualification may be lacking. Disadvantages for the buyer include: the seller may not be able to deliver marketable title at the end of the contract period, but the buyer must make payments nevertheless; or the seller may cloud the title with liens; or the seller may not have applied the buyer’s payments to the seller’s necessary loan payments.