Wraparound Mortgage and the Due-on-Sale Clause: What the Law Says

What a wraparound is, and what “subject to” means

Texas is one of the few states that defines the term in a statute. Finance Code 159.001(7) says a wrap mortgage loan is a residential mortgage loan made to finance the purchase of residential real estate that will “continue to be subject to an unreleased lien” securing a debt “incurred by a person other than the wrap borrower,” and the new loan's principal includes both the outstanding balance of that older debt and any remaining part of the price the seller finances. A Texas court of appeals decision quoted in a federal bankruptcy ruling (586 B.R. 831, Western District of Texas, May 3, 2018) puts it as “subsequent and subordinate mortgage secured by real property upon which there exists a first mortgage that is outstanding and unsatisfied,” and adds that the wraparound seller “remains personally liable under any prior obligation, but the purchaser never becomes personally obligated for such.”

In plain terms: the seller's bank loan stays where it is, in the seller's name, and the buyer signs a bigger note to the seller. The seller keeps paying the bank out of the buyer's payments and keeps the difference.

A “subject-to” purchase is the same transfer without the second note: the buyer takes title and the seller's loan stays in place. Fannie Mae's Servicing Guide does not use the slang, but it tells servicers to count “the purchase of a property ‘subject to’ the mortgage loan” as a transfer of ownership (D1-4.1-01, 11/12/2014), and so does 12 CFR 191.2(a). A land contract (contract for deed) is a third version in which the buyer gets possession and the seller keeps title; our guide to contract for deed and land contract laws by state covers the state rules and we do not repeat them here. How seller financing is priced and taxed is in our seller financing guide for real estate investors.

The clause, word for word: Section 18

Almost every residential first mortgage written on the Fannie Mae/Freddie Mac uniform instrument contains the same paragraph. We read Section 18 from the Maryland version, Form 3021 1/01, as posted by the Consumer Financial Protection Bureau (Section 18 is a uniform covenant; we read only the Maryland form):

“As used in this Section 18, ‘Interest in the Property’ means any legal or beneficial interest in the Property, including, but not limited to, those beneficial interests transferred in a bond for deed, contract for deed, installment sales contract or escrow agreement, the intent of which is the transfer of title by Borrower at a future date to a purchaser.”

The operative sentence follows: if all or any part of the property “or any Interest in the Property is sold or transferred ... without Lender's prior written consent, Lender may require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if such exercise is prohibited by Applicable Law.”

Three things matter for a wrap or subject-to deal (our reading):

1. The clause is an option, not an automatic default. The lender “may” require payment in full. It is the servicer guides, below, that turn the option into an instruction for loans owned or securitized by the two agencies.
2. A land contract is inside the definition by name. A buyer who takes possession under a contract for deed has an “Interest in the Property” under the form's own words.
3. The last sentence points to federal law. “Applicable Law” is where the Garn-St Germain exceptions come in.

What federal law says: 12 U.S.C. 1701j-3 and 12 CFR part 191

The Garn-St Germain Depository Institutions Act of 1982 (Pub. L. 97–320, title III, §341, Oct. 15, 1982) put the due-on-sale rule in section 1701j-3 of Title 12. The section has subsections (a) through (g), not four. The ones that matter:

• (a)(1) defines the clause as one that “authorizes a lender, at its option, to declare due and payable sums secured by the lender's security instrument if all or any part of the property, or an interest therein, securing the real property loan is sold or transferred without the lender's prior written consent.”
• (b)(1) says that “Notwithstanding any provision of the constitution or laws (including the judicial decisions) of any State to the contrary, a lender may, subject to subsection (c), enter into or enforce a contract containing a due-on-sale clause.”
• (b)(2) says that, except as subsection (d) provides, the exercise of the option “shall be exclusively governed by the terms of the loan contract.”
• (b)(3) says a lender “is encouraged to permit an assumption” at the existing rate or at a rate between the contract and market rates, and that nothing in the section prohibits it.

Subsection (d) is the list of exceptions, and it is limited to a loan secured by “residential real property containing less than five dwelling units.” On that property a lender may not exercise the clause on:

Source: 12 U.S.C. 1701j-3(d), United States Code 2024 edition as published by GovInfo; 12 CFR 191.5(b), eCFR version dated October 1, 2026.

The rule that implements the statute, 12 CFR part 191, is now an OCC regulation (the part's source note is 76 FR 49154, Aug. 9, 2011, and its text refers to “the OCC's regulations”). It closes the question for the structures in this guide. Section 191.2(a) says “assumed” includes “transfers of real property subject to a real property loan by assumptions, installment land sales contracts, wraparound loans, contracts for deed, transfers subject to the mortgage or similar lien, and other like transfers.” Section 191.2(b) defines a sale or transfer as the conveyance of any right, title or interest, “whether legal or equitable, whether voluntary or involuntary,” by outright sale, deed, installment sale contract, land contract, contract for deed, a “leasehold interest with a term greater than three years, lease-option contract or any other method of conveyance of real property interests.”

Section 191.5(b) is where the statute's list gets narrower. It applies “With respect to any loan on the security of a home occupied or to be occupied by the borrower,” and for a transfer to a relative, spouse or child it requires that the transferee be “a person who occupies or will occupy the property.” The statute says “less than five dwelling units”; the regulation adds the occupancy condition (our reading: a rented-out duplex or a rental house is, on the regulation's words, outside the protection even when the transfer is to a child). Our guides on quitclaim deeds, deeding a home into a living trust and moving a rental into an LLC cover those protected-or-not transfers one by one.

Two protections in the regulation do help a seller who is called. A lender “shall not impose a prepayment penalty or equivalent fee” when it declares by written notice that the loan is due under a due-on-sale clause or starts foreclosure to enforce it (12 CFR 191.5(b)(2)). And a lender “waives its option” for a specific transfer if, before the transfer, the lender and the buyer agree in writing that the buyer will be obligated under the loan (191.5(b)(4)). That is the formal route to an assumption, and 1701j-3(b)(3) says lenders are “encouraged” to allow one.

Why the clause is enforceable: de la Cuesta (1982)

Before the 1982 Act, states such as California limited a lender's right to call a loan on a sale to cases where the lender's security was impaired. In Fidelity Federal Savings & Loan Assn. v. de la Cuesta, 458 U.S. 141 (argued April 28, 1982, decided June 28, 1982), the Supreme Court held that the Federal Home Loan Bank Board's regulation pre-empted that state rule for federal savings and loan associations. The opinion, by Justice Blackmun for a six-justice majority, reversed the California Court of Appeal (121 Cal. App. 3d 328). The official syllabus summarizes the holding this way: the state rule “forbids a federal savings and loan association to enforce a due-on-sale clause at its option and deprives the association of the flexibility given it by the Board.” The facts are familiar: the lender “was not notified prior to each appellee's purchase of property; when it did learn of the transfer, it gave notice of its intent to enforce the due-on-sale clause.” Congress then wrote the same result into the statute for all lenders in October 1982, and 12 CFR 191.5(a) now says due-on-sale practices are governed by the federal rules “in preemption of and without regard to any limitations imposed by state law.” The practical effect is that a state court cannot treat a wrap as safe on the theory that the bank's collateral is not harmed.

What the servicers' guides say: “must accelerate”

For most U.S. home loans the decision to call is not discretionary at the servicer level, because Fannie Mae and Freddie Mac tell servicers what to do. We read both guides.

Source: Fannie Mae Servicing Guide D1-4.1-01, D1-4.1-02 and D1-4.1-05, read at servicing-guide.fanniemae.com (Guide published August 12, 2026); Freddie Mac Single-Family Seller/Servicer Guide chapter 8406 from the Guide PDF compiled as of Bulletin 2025-6 (May 7, 2025), the latest compilation we could read. Later bulletins may have changed the text.

Both guides describe loans the agencies own or guarantee. A loan held by a bank in its own portfolio, or a private-money or hard-money loan, follows whatever the note and deed of trust say and whatever that lender chooses (our reading), but the same federal rule applies to those lenders too: 12 CFR 191.2(g) defines “lender” to include banks, credit unions, finance companies and individuals.

What happens on acceleration

Pulling the documents together, the sequence for a loan on the uniform instrument runs like this (our reading of the documents; the loan's own terms and state law control):

1. The lender learns of the transfer. Fannie Mae's guide tells servicers to “investigate any questionable changes” and to look into transfers when asked for a statement of account (D1-4.1-01).
2. Notice of acceleration. Section 18 requires the lender to give notice and “a period of not less than 30 days from the date the notice is given” to pay all sums secured. If the borrower does not pay in that period, the lender “may invoke any remedies permitted by this Security Instrument without further notice or demand.”
3. Reinstatement. Section 19, “Borrower's Right to Reinstate After Acceleration,” lets a borrower stop enforcement by paying “all sums which then would be due under this Security Instrument and the Note as if no acceleration had occurred,” plus expenses, up to the earliest of five days before a power-of-sale foreclosure sale, another period under state law, or entry of a judgment. Whether that right applies to a due-on-sale acceleration, and what it means for a wrap buyer who is not a borrower on the bank's note, are questions for an attorney in that state (our reading).
4. Foreclosure. Both servicer guides direct foreclosure if the balance is not paid. The federal rule bars a prepayment penalty on the payoff (12 CFR 191.5(b)(2)).

A federal bankruptcy decision, 586 B.R. 831 (Bankr. W.D. Tex. May 3, 2018), shows how this looks after the fact. The facts there: a note and deed of trust from April 2008 were later assigned to a bank; in July 2014 a buyer took the San Antonio house under a “Note and Deed of Trust to Secure Assumption with a five year balloon payment”; the buyer filed chapter 13 in 2017 and the bank filed a secured claim of $243,010.89, which “includes arrears of $17,431.30.” The court denied the chapter 13 trustee's objection that the buyer had no contract with the bank, noting that there was “no evidence that Creditor contested the sale of July 3, 2014,” that the bank “does not object to its treatment” under the plan, and that wraparound mortgages “are valid under Texas law.” The court distinguished two earlier decisions in which the lender did object. In one of them, as the court described it, a chapter 13 “debtor who obtained residential mortgage property from the original mortgagor without adhering to the due-on-sale clause is not permitted to cure the mortgage defaults through the Chapter 13 plan over the objection of the mortgage holder” (355 B.R. 674, Bankr. N.D. Ill. 2006); in that decision, as the court described it, the lender's earlier failure to invoke the clause and its acceptance of payments did not bar it from enforcing the clause. The lesson is that the result turned on what the lender chose to do (our reading). We found no other primary-source court opinion on a wrap's acceleration that we could read in full through the free CourtListener index within our ten-call limit, so this is one decision, not a pattern.

The arithmetic of the spread (our arithmetic)

The reason sellers and investors do wraps is the gap between two interest rates. The numbers below are assumptions we chose, not market quotes, and the script is saved with the data (calc_wrap.py).

Assumptions: a $400,000 sale; the buyer pays $40,000 down (10%); the seller finances $360,000 on an 8.0% fixed note over 30 years; the seller's existing loan has a $200,000 balance at 3.5% fixed with 300 months left.

Two readings of the same numbers (our arithmetic):

• The seller's return. Month-1 interest on the wrap is $2,400.00 and on the bank loan $583.33. The $1,816.67 difference, annualized, is 13.6% on the $160,000 gap between the two balances. That is the incentive to do a wrap, and it is paid for with the bank's below-market rate, which exists only while the clause is not enforced.
• The stress. If the bank calls the loan, $200,000 is due at once. A seller who cannot pay it or refinance it must sell or lose the property to foreclosure, and the buyer's $40,000 down payment and monthly payments are exposed, because the buyer's only contract is with the seller (our reading). Even if the seller could refinance at an assumed 7%, the underlying payment rises from $1,001.25 to $1,413.56 and the spread falls from $1,640.31 to $1,227.99 a month. For reference, the IRS's October 2026 table (Rev. Rul. 2026-19) lists a mid-term applicable federal rate of 4.61% and a long-term rate of 5.22% at annual compounding, both below our assumed 8.0%; how those rates apply to a seller note is covered in our seller financing guide.

Texas as the model for state wrap rules

Most states have no wrap statute and rely on contract and deed-of-trust law. Texas wrote one after a 2021 bill (S.B. 43, effective January 1, 2022), and the text shows what a state rule can add to the federal one. We read Finance Code chapter 159 on the Texas Legislature's official site through an archived capture dated March 4, 2025; amendments after that date are not verified.

Source: Texas Finance Code chapter 159, official site statutes.capitol.texas.gov, archived capture of March 4, 2025.

Property Code 5.016 applies to any residential conveyance in which a recorded lien stays on the property, wrap or not. The seller must give “the purchaser and each lienholder” a written disclosure at least seven days before the earlier of conveyance or contract, topped by this warning: “IT IS POSSIBLE THE LIENHOLDER COULD DEMAND FULL PAYMENT OF THE OUTSTANDING BALANCE OF THE LIEN IMMEDIATELY.” If the notice is not given, the purchaser may terminate “for any reason on or before the seventh day after” receiving it, though “a violation of this section does not invalidate a conveyance.” Exemptions include a transfer where the purchaser obtains a title insurance policy insuring the transfer, and a person who has bought, conveyed or contracted to convey real property “four or more times in the preceding 12 months” (5.016(c)(10)-(11)). Because the notice goes to each lienholder as well, the statute puts the consent question in writing in front of the bank (our reading). The statute does not make the transfer legal against the lender; it makes the risk visible to the buyer. Texas executory contracts for land are in Property Code chapter 5, subchapter D, which our contract for deed guide covers.

We did not read the wrap or subject-to rules of other states for this page. If the property is outside Texas, an attorney licensed there should confirm what the state requires.

Federal seller-financing rules: where they stop

A seller who finances a wrap on a home touches three federal rules, and the exclusions are narrower than many summaries say. We read all of them in the eCFR version dated October 1, 2026.

• Regulation Z may not apply at all. Section 1026.3(a)(1) exempts “An extension of credit primarily for a business, commercial or agricultural purpose,” and 1026.3(a)(2) exempts credit “to other than a natural person.” A wrap sold to a buyer who will rent the house, or to an LLC, is outside the part (our reading). A wrap to a buyer who will live in the house is a consumer credit transaction secured by a dwelling, defined in 1026.2(a)(19) as “a residential structure that contains one to four units.”
• Who counts as a “creditor.” Under 1026.2(a)(17)(v) a person “regularly extends consumer credit” only if it extended credit “more than 25 times (or more than 5 times for transactions secured by a dwelling) in the preceding calendar year.” The ability-to-repay rule, 1026.43(c)(1), applies to a creditor: “A creditor shall not make a loan that is a covered transaction unless the creditor makes a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan.” There is no separate seller-financing exemption in that section that we found; a seller who does not meet the creditor definition is simply not a creditor (our reading).
• Loan originator rules, 1026.36(a)(4) and (a)(5). These are exclusions from the definition of “loan originator,” not from the ability-to-repay rule. The three-property exclusion covers a person who provides seller financing for “three or fewer properties in any 12-month period” and requires that the financing be “fully amortizing,” that the person determine “in good faith the consumer has a reasonable ability to repay,” and that the rate be “a fixed rate or an adjustable rate that is adjustable after five or more years.” The one-property exclusion is for a “natural person, estate, or trust,” limited to “only one property in any 12-month period,” and requires a schedule that “does not result in negative amortization” and a fixed or five-year-plus adjustable rate. A wrap with a balloon, such as the five-year balloon in the Texas case above, does not meet the “fully amortizing” condition of the three-property exclusion (our reading); it would have to fit the one-property exclusion, which has no amortization requirement beyond no negative amortization.

We did not read the SAFE Act statute itself for this page; the federal exclusions above are those in Regulation Z. Texas layers its own licensing rules on top (Finance Code 159.051 requires a wrap lender to be licensed or registered, or exempt, under chapters 156, 157 or 342).

What a reader can do with this

A wrap or subject-to deal is a legal structure with a known failure point, so these are questions to bring to a real estate attorney licensed in the state where the property sits, not steps to follow from a web page. We do not match readers with an adviser here, because the person who can help is an attorney (and, for the closing, a title company or closing attorney).

• Read the seller's deed of trust and note. Find the transfer paragraph (Section 18 on the uniform instrument) and check what it counts as a transfer.
• Find out who owns and services the loan. The two agency guides above only govern loans the agencies own or guarantee; the servicer's name and the investor are on the mortgage statement or can be requested.
• Ask whether a written consent or assumption is available. Under 12 CFR 191.5(b)(4) a written agreement before the transfer waives the option for that transfer; federal law “encourages” assumptions (1701j-3(b)(3)).
• Check whether an exception can apply. The list is on the table above, and the regulation's occupancy condition matters.
• Ask where the payments go. In Texas the statute puts payments in trust and imposes a fiduciary duty (159.151-159.152); elsewhere, ask for an escrow or third-party servicer arrangement in writing.
• Price the call. The stress case above shows what a $200,000 call means; a seller's plan for paying it, and a buyer's plan if it happens, are worth writing down before closing.
• Check insurance and taxes. Texas requires a notice that the seller's insurance “MAY NOT PROVIDE COVERAGE TO THE BUYER” (159.101(a)(2)); we did not check other states.

For the tax side of a seller-financed sale (installment method, interest rate floors, recapture) see our seller financing guide.

FAQ

Sources, read and saved on October 13, 2026: 12 U.S.C. 1701j-3 (United States Code, 2024 edition, GovInfo); 12 CFR part 191 and 12 CFR 1026.2, 1026.3, 1026.36 and 1026.43 (eCFR, versions dated October 1, 2026); Fannie Mae/Freddie Mac uniform instrument Form 3021 1/01 (Maryland deed of trust, copy published by the Consumer Financial Protection Bureau, Sections 18 and 19); Fannie Mae Servicing Guide D1-4.1-01, D1-4.1-02, D1-4.1-05 and D1-4.2-02 (servicing-guide.fanniemae.com); Freddie Mac Single-Family Seller/Servicer Guide chapter 8406 (Guide PDF current as of Bulletin 2025-6, May 7, 2025); Fidelity Federal Savings & Loan Assn. v. de la Cuesta, 458 U.S. 141 (1982) (Library of Congress United States Reports); 586 B.R. 831 (Bankr. W.D. Tex. 2018) (CourtListener, excerpted); Texas Finance Code chapter 159 and Property Code 5.016 (Texas Legislature official site, archived capture of March 4, 2025); Rev. Rul. 2026-19 (IRS). The Texas copies, the Freddie Mac Guide and the uniform-instrument copy are older than October 13, 2026, and later changes are not verified. This is analysis of public documents, not investment, legal or tax advice.