All-inclusive deed of trust

     An all inclusive deed of trust ("AITD"), sometimes referred to as a "wrap around deed of trust," secures an obligation which is inclusive of a secured obligation owed by the creditor to a third party.   The use of an all inclusive deed of trust facilitates the assumption of existing loans by subsequent purchasers of real property. 

     For example, suppose a piece of real property is encumbered by a deed of trust securing a loan with a balance due of $1 million. The seller wants to sell for $2 million and agrees to take a $500,000 down payment and carry back a secured promissory note for $500,000.  The buyer must come up with a loan of $1 million.    If the $1 million dollar outstanding loan has a favorable interest rate and no due-on-sale clause, the buyer will likely be interested in assuming the obligation on that loan rather than procuring a new loan for $1 million at a higher interest rate.   Absent a novation with the original lender substituting the buyer as obligor on the $1million note, the seller remains liable on the note and will continue to pay it from the proceeds of the buyer's payment to the seller on the $1.5 million note.  To secure such payment from the buyer and to secure the additional $500,000 owed the seller, the seller will take a promissory note from the buyer in the amount of $1.5 million and secure that note with a deed of trust which "wraps" the first deed of trust held by the original lender but which is second to it.  

     Because the favorable interest rate on the assumable $1 million loan makes the property more marketable, the seller can insist on an interest rate on the $1.5 million note which exceeds the rate on the $1 million loan and which fairly compensates the seller for carrying back $500,000. Since the interest rate on the $1.5 note is higher than that of the "underlying" $1 million note, the seller receives what amounts to a windfall -- the difference between the interest rate he or she is paying on the first and the rate he or she is receiving on the $1.5 million note.   By structuring the transaction in this way, the seller to retains control over payments on the $1 million note and can assure that payments are timely made.  If the buyer defaults on the $1.5 million note, the seller can foreclose. 

     You might be wondering why a buyer would agree to this, when in fact he or she could simply assume the first. Perhaps the seller is the only source of financing for the $500,000 the buyer needs to buy the building, and the seller will not do the deal without the AITD. Perhaps the institutional interest rates for a $500,000 second equal or surpass the rate that the seller is willing to give on the AITD, and the lower rate on a greater sum makes more financial sense than the higher rate on the second. By agreeing to AITD the buyer also avoids any loan fees, points and other expenses that can be incurred when obtaining a new loan.

     FPCI Re-Hab 01 v. E & G Investments, Inc. case illustrates some of the mechanical problems associated with the foreclosure of an AITD. There are many issues that need to be addressed in drafting an AITD, many of which center around the possibility of foreclosure. For example, is the buyer or the seller responsibile for making payments on the underlying note ($1 million in our example).  What is the recourse of the buyer against the seller if the buyer makes such payments to the seller but the seller fails to pay the underlying note and the holder of the first deed of trust forecloses?  What if the underlying note becomes due and payable in full for reasons other than non-payment?    Consideration of these and other issues relating to the AITD are beyond the scope of these materials.