The wrap-around mortgage, and related documentation, must not permit the mortgagor to pay the first mortgagee directly
Except for substitution of the Bank in place of the Investor as the wrap-around mortgagee, all other loan attributes remain the same: the Buyer gets the benefit of below market interest [9% instead of 9.5%]; the Seller receives all of its equity to invest or use as Seller determines appropriate; the original lender continues to receive the benefit of its contracted for fixed interest rate over the term of its loan; and the Bank, as wrap-around mortgagee, receives an effective interest yield of %. Everyone wins.
For the most part, a wrap-round mortgage should mirror the provisions of the senior mortgage around which it “wraps”, with a pass through to the mortgagor of virtually all mortgagor covenants. An essential element of a wrap-around mortgage, however, is that it must require the borrower to make all payments to the wrap-around mortgagee, who will, in turn, be obligated to pay the senior mortgagee. It is this arrangement which, legally, may enhance the wrap-around mortgagee’s collateral position.
Although not entirely clear from reported case law, at least one respected commentator has suggested that this migration of lien priority is a natural consequence of applicable subrogation law. Judicial interpretation of this proposition in the context of wrap-around mortgages, https://paydayloanscolorado.org/ however, has been scant, and in most jurisdictions non-existent.
In addition to the yield enhancement benefits enjoyed by the wrap-around lender, another advantage of a wrap-around mortgage as compared with a simple “second mortgage” is that the collateral priority of a wrap-around mortgage may, over time, migrate to a collateral priority on par with the first mortgage
While this legal position appears sound in circumstances where the indebtedness secured by a superior lien is paid in full , its application to partial payments under a wrap-around mortgage with pro rata subrogation remains largely untested.
Still, building a case for preservation of this outcome is desirable. Accordingly, the wrap-around mortgage and supporting documentation should include covenants of subrogation to establish the clear intent of the parties that subrogation to the lien of the senior loan is to occur with each payment by the wrap-around mortgagee to the senior lender. By inclusion of specific language to this effect, the doctrine of “conventional subrogation” may be sufficient to achieve this result.
From an underwriting standpoint, however, until this issue is definitively settled through judicial interpretation or otherwise, it is appropriate to analyze a proposed loan secured by a wrap-around mortgage as being a loan secured by a junior mortgage
Some commentators have raised the additional issue of whether future payments by a wrap-around mortgagee to a senior lender enjoy priority over liens filed subsequent to the date of recording a wrap-around mortgage but prior to the date of payment of future installments to the senior lender. This issue is implicated because most wrap-around mortgages provide that the wrap-around mortgagee is required to pay the senior lender only to the extent of funds actually received from the wrap-around mortgagor, giving rise to the legal dichotomy between obligatory future advances and non-obligatory future advances .
The prevailing view is that this issue is adequately resolved through conventional subrogation and through the rule of “tacking”, which provides that a mortgagee who pays a prior encumbrance (whether or not subrogation applies) is entitled to include such amount in the indebtedness secured by the lien of its mortgage.
Other covenants are useful or necessary to preserve the yield enhancement provided by use of a wrap-around mortgage. In particular, a covenant in the wrap-around mortgage that the underlying first mortgage may not be prepaid by the wrap-around mortgagor is essential, since it is the interest rate spread between the wrap-around mortgage and the underlying first mortgage that enhances the effective yield to the wrap-around mortgagee. Also, a cross-default provision in the wrap-around mortgage, providing that a default under the senior mortgage will constitute a material default under the wrap-around mortgage, is a useful protective covenant.