Wrap Around Mortgage in Texas: Disclosures, Escrow, and Risks

A wraparound mortgage in Texas is a seller-financed home sale in which the seller’s existing mortgage stays in place and the buyer signs a new, larger note that “wraps around” the unpaid balance. The buyer pays the seller each month, and the seller uses part of that payment to keep the underlying loan current. Texas regulates these deals more tightly than most states: specific written disclosures, a third-party escrow agent, and a closing handled by an attorney or title company are all mandatory, and skipping the last one voids the wrap lien entirely.

How the Structure Works

In a normal sale the seller’s mortgage is paid off at closing. A wraparound skips that payoff. If the seller still owes $150,000 and sells for $250,000, the wrap note is written for the full $250,000. The buyer pays the seller on that larger number, and the seller forwards enough of each payment to cover the $150,000 obligation to the original lender.

The seller profits from the spread between the two interest rates. A 4% underlying loan and a 6% wrap note leaves the seller with a 2% margin on the underlying balance plus principal payments on their own equity. The wrap note sits in a junior lien position behind the original mortgage, so the original lender still has first claim on the property.

Buyers who cannot qualify for conventional financing turn to wraps because the seller sets the qualification terms. Sellers use them to move a slow-to-sell property or to generate interest income. Both sides are taking on risks the law tries to channel through specific requirements.

The Due-on-Sale Clause Is the Biggest Risk

Nearly every conventional mortgage lets the lender demand the full remaining balance if the borrower transfers an interest in the property without written consent. Federal law explicitly allows lenders to enforce these clauses and preempts any state law to the contrary.¹

A wraparound is exactly the kind of transfer those clauses target. If the original lender finds out, it can accelerate the loan. If the seller cannot pay the accelerated balance, the lender can start foreclosure, and the buyer can lose the home even while making every payment on time. Many lenders do not actively monitor for wraps when payments keep arriving, but counting on a lender’s inattention is not a legal protection. Both parties should go in understanding that the underlying loan can be called at any time.

Written Disclosures Before the Buyer Signs

Texas Property Code § 5.016 requires any seller conveying residential property that will still be subject to a recorded lien at closing to deliver a written disclosure to the buyer and to every existing lienholder. Delivery must happen at least seven days before the earlier of the conveyance date or the date the buyer signs an executory contract, option, or other binding agreement.²

The written statement has to identify each lienholder by name, address, and phone number; state the balance secured by each lien; and give the interest rate, periodic payment amount, and account number for each existing debt.

If the seller delivers the disclosure late, the buyer may cancel the contract for any reason within seven days after finally receiving it. The sale is not automatically void, but the buyer gets a clear exit along with any other remedies Texas law provides.²

Several transactions are exempt from § 5.016: sales in which the buyer obtains a title insurance policy insuring the transfer, transfers resulting from a court order or foreclosure, transfers between co-owners or spouses, and sales to a buyer who has purchased or contracted to purchase four or more properties in the preceding twelve months. There is also a safe harbor if the seller reasonably believed and took steps to ensure that each undisclosed lien would be released within 30 days of the title transfer.²

Payments Must Run Through a Third-Party Escrow Agent

Texas Finance Code Chapter 159 requires that a residential wraparound mortgage loan be administered through a third-party escrow agent. The agent receives each monthly payment from the buyer, forwards the portion owed to the original lender, and tracks the declining balances on both the wrap note and the underlying loan.³

At closing the seller must give the escrow agent a copy of the payment schedule for the original mortgage, the name, address, and phone number of the original lender, the original loan number, and the periodic payment amount due on that loan.

If the buyer’s payment falls short of what the original lender is owed, the escrow agent must notify both the buyer and the seller. That notification requirement is the practical reason for the whole structure: without it, a seller could pocket the buyer’s payments and quietly let the underlying mortgage fall behind until the original lender starts foreclosure on a buyer who thought everything was current.³

Closing Must Be Handled by an Attorney or Title Company

This is the rule most informal wrap deals get wrong. Under Texas Finance Code § 159.105, the lien securing a wraparound mortgage loan is void unless the wrap mortgage and the property conveyance are closed by an attorney or a title company.⁴

A void lien means the seller has no enforceable security interest in the property. If the buyer stops paying, the seller cannot foreclose on the wraparound deed of trust. Saving on closing costs by handling the paperwork privately can wipe out the seller’s ability to recover the home, no matter how carefully the rest of the deal was documented.

The Note and the Deed of Trust

Two documents carry the transaction: a wraparound promissory note and a wraparound deed of trust.

The promissory note states the total amount the buyer owes, including the balance of the seller’s existing loan plus the seller’s equity, along with the interest rate, payment schedule, and maturity date. It should include pass-through language identifying which portion of each payment covers the underlying obligation. The figures gathered during the § 5.016 disclosure feed directly into the note.

The deed of trust is the security instrument. It must identify the existing mortgage, acknowledge the due-on-sale clause, and describe how the wrap loan interacts with the underlying debt. It should also allocate responsibility for property taxes and insurance, since both the underlying lender and the seller depend on those staying current. If the buyer defaults, the deed of trust is what gives the seller a path to foreclosure. Ambiguous pass-through terms or poorly drafted foreclosure provisions are a common reason wrap deals fall apart in court.

Recording and Annual Accounting

After closing, the signed and notarized wraparound deed of trust should be recorded with the county clerk in the county where the property sits. Recording creates the public record of the buyer’s interest and fixes the priority of the wrap lien against any later claim. Lien priority in Texas generally follows recording order, so a delay can let another creditor jump ahead.

For executory contracts, Texas Property Code § 5.077 requires the seller to send the buyer an annual accounting statement, postmarked no later than January 31 each year. The statement must show the amount paid, the remaining balance, the number of payments left, any amounts paid to taxing authorities or insurers on the buyer’s behalf, and an accounting of any insurance proceeds applied to the property.⁵

A seller who completes fewer than two of these transactions in a twelve-month period and misses the statement owes the buyer $100 in liquidated damages per missed statement plus reasonable attorney’s fees. A seller handling two or more such transactions faces $250 per day past the January 31 deadline, capped at the property’s fair market value.⁵

Federal Rules Cap How Often a Seller Can Do This

Regulation Z under the Truth in Lending Act limits who can offer seller financing without becoming a licensed loan originator. Two exemptions cover most individuals, each with conditions.

One Property in Twelve Months

A natural person, estate, or trust that finances the sale of only one property in any twelve-month period is not treated as a loan originator, provided the seller owns the property, did not build it as a contractor, and the financing does not produce negative amortization. The rate must be fixed, or adjustable only after five or more years with reasonable lifetime caps. Under this exemption the seller does not have to verify the buyer’s ability to repay, and balloon payments are permitted.⁶

Three Properties in Twelve Months

A seller financing three or fewer properties in a twelve-month period gets a broader exemption that also covers entities such as LLCs. The terms are stricter: the loan must be fully amortizing with no balloon, and the seller must determine in good faith that the buyer can reasonably afford the payments, which means reviewing income, employment, debts, and credit. The same interest rate restrictions apply.⁶

A seller who exceeds three financed sales in a twelve-month period or fails an exemption condition is treated as a loan originator and must comply with federal licensing and ability-to-repay rules. Anyone doing wrap deals regularly can cross this line quickly.

Tax Treatment for the Seller

A wraparound is an installment sale for federal tax purposes. Instead of reporting the entire gain in the year of sale, the seller spreads it across the years payments arrive. Each payment the seller collects breaks into three parts: interest income, a tax-free return of basis, and taxable gain on the sale.⁷

Sellers report installment sale income on IRS Form 6252.⁸ They also must issue a Form 1099-INT to the buyer for any interest received of $10 or more during the year.⁹ On the buyer’s side, the interest paid on the wrap note can generally be deducted as home mortgage interest, because the IRS treats a wraparound as secured debt for purposes of the mortgage interest deduction.¹⁰

One trap worth flagging: when the wraparound mortgage exceeds the seller’s adjusted basis in the property, the excess is treated as a payment received in the year of sale, which can create a tax bill before the seller has collected much cash. Running the numbers past a tax professional familiar with installment sales before closing is the practical move.⁷

Insurance

Both the original lender and the seller need to be protected on the homeowner’s policy. The original lender is already listed as a mortgagee. The seller should be added as a lender’s loss payee, not a simple loss payee. A standard loss payee can lose the right to collect if the homeowner does something to invalidate the policy; a lender’s loss payee keeps that right and gets advance notice of cancellation. For the buyer, keeping coverage in place is not optional, because a lapse can trigger default on both the underlying loan and the wrap note at the same time.

1
Office of the Law Revision Counsel. 12 USC 1701j-3 – Preemption of Due-on-Sale Prohibitions
2
State of Texas. Texas Property Code 5.016 – Conveyance of Residential Property Encumbered by Lien
3
State of Texas. Texas Finance Code Chapter 159 – Wrap Mortgage Loan Financing
4
State of Texas. Texas Finance Code 159.105 – Enforceability of Lien
5
State of Texas. Texas Property Code 5.077 – Annual Accounting Statement
6
eCFR. 12 CFR 1026.36 – Prohibited Acts or Practices and Certain Requirements for Credit Secured by a Dwelling
7
Internal Revenue Service. Publication 537 – Installment Sales
8
Internal Revenue Service. About Form 6252 – Installment Sale Income
9
Internal Revenue Service. About Form 1099-INT – Interest Income
10
Internal Revenue Service. Publication 936 – Home Mortgage Interest Deduction