DAVID J. WILLIS ATTORNEY
Copyright © 2013. All rights reserved worldwide.
ASSUMPTION TRANSACTIONS IN TEXAS
by David J. Willis, J.D., LL.M.
What is an assumption?
The essential features of an assumption are (1) the buyer takes title to the property by means of an "assumption deed" with vendor´s lien, containing either general or special warranties; and (2) the buyer obligates himself to pay the balance of the indebtedness that is being assumed. Additional documents such as an assumption agreement may also be executed.
An assumption may be accomplished with or without the consent of the lender, although certain risks may exist if title to the property is transferred without such consent. Nonetheless, the vast majority of assumptions occur "unofficially" without lender consent. In such cases, the buyer obligates himself or herself to pay the assumed indebtedness, but this promise is made to the seller, not the lender. Note that the only way one becomes obligated to a lender is to sign a note to that lender. Similarly, the only way one is released from an obligation to a lender is for the lender to sign and record a release of lien.
What is the difference between an assumable and a non-assumable loan?
Most all loans today are referred to as "non-assumable." This is meant to be contrasted with certain types of loans in years past that could be fully assumed merely by paying an assumption fee and notifying the lender of the new owner.
But is the term "non-assumable" really accurate? No, it is not. In understanding why, one must first understand that the concept of title (evidenced by a warranty deed) is separate from the concept of debt (evidenced by a note to a lender secured by a deed of trust). An owner of property is almost always entitled to transfer title to property whenever and to whomever he wishes. However, doing so does not relieve the seller from legal responsibility to pay the note (since the seller signed it), nor does it automatically obligate the buyer to pay it (since the buyer did not sign it). A deed transfers title – that´s all.
The assumability issue is relevant in determining whether or not the lender will allow substitution of one obligor on the note for another. In other words, the question is: will the lender let the seller off the hook for the debt and replace him under the note with the borrower? The answer is almost always no. Lenders want the buyer to apply, qualify, pay fees, and get a new loan.
If an owner transfers title, has he committed an illegal act? Has he breached the covenants of his deed of trust? Absolutely not. Lenders, of course, would prefer to be notified if a loan is going to be assumed by a third party, and then to impose costs and conditions, but they have no absolute right to that. They have only the post-transfer option to accelerate the debt – and this rarely happens when payments are kept up to date. These days, lenders have their hands full with monetary defaults.
What about the due-on-sale clause?
An assumption transaction is neither a breach of contract nor a "violation" of the due-on-sale clause. If you look carefully at the typical lender´s residential deed of trust, you will see that it usually does not prohibit a transfer of property without the lender´s consent. Instead, it states that if the borrower transfers title to the property without the lender´s permission then the lender may, if it so chooses, declare the loan due. Look at paragraph 18 of the Fannie Mae/Freddie Mac Uniform Deed of Trust:
If all or any part of the Property or any interest in the Property is sold or transferred (or if Borrower is not a natural person and a beneficial interest in Borrower 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.
This is not prohibitory language. It says the lender may accelerate the note if it wants to. When an investor transfers the property without consent from the lender, the investor makes it possible for the lender, if the lender so chooses, to accelerate. It is not a breach of the deed of trust. It is not fraud. As attorney Bill Bronchick puts it, "There is no due on sale jail."
How often does a lender declare an otherwise performing loan due? Lenders may not like the fact that the property has been sold to someone else, but – so long as payments continue on a timely basis – the risk that a lender will take any serious action is small. It is common, however, for the seller to receive a nasty letter from the lender making a threat about foreclosure if the new buyer does not apply and qualify; but it usually ends there, with no follow-up to the threat.
Is an assumption the same thing as a wrap?
No. In a wrap, a new wraparound note from buyer to seller is created. In other words, the buyer becomes obligated to the seller on a new wraparound note, which is secured by a wraparound deed of trust; and the seller remains obligated on the first-lien note (which is "wrapped") until it is paid and released. These obligations coexist.
In an assumption, the buyer expressly assumes responsibility for paying the existing first-lien note by promising the seller that he will do so. There is no new note. This contrasts with a wraparound transaction, where the first-lien note remains the exclusive responsibility of the seller.
What is the difference between an assumption and a "subject to" transaction?
Again, in an assumption, the buyer promises to pay the existing note. In a "subject to" deal, the buyer takes title by means of a warranty deed but does not obligate himself to pay the note. He might make payments on the existing note or he might not.
This is a typical assumption clause contained in a warranty deed:
As further consideration, Grantee promises to keep and perform all of the covenants and obligations of the Grantor contained in the Assumed Note and the Deed of Trust and (subject to any non-recourse provisions that may apply) to indemnify, defend, and hold Grantor harmless from any loss, attorney´s fees, expenses, or claims attributable to a breach or default of any provision of this assumption by Grantee. Grantee shall commence payments on the Assumed Note on or before the next regular due date under the Assumed Note.
This is a typical "subject to" clause:
This conveyance is made subject to any and all indebtedness of Grantor and liens against the Property, including but not limited to that certain indebtedness and liens securing same evidenced by a note in the original principal amount of $_________, dated _______________, executed by Grantor and payable to the order of _____________________, which note is secured by a vendor´s lien retained in deed of even date recorded at Clerk´s File No. _________________in the Real Property Records of ________ County, Texas, and is additionally secured by a deed of trust of even date to ________________, Trustee, recorded at Clerk´s File No. ________________ in the Real Property Records of ____ County, Texas. Grantee does not assume payment of this or any other indebtedness of Grantor. Grantor indemnifies and holds Grantee harmless from any and all liens, liabilities, debts, causes of action, damages, or claims of any kind that exist or may arise against the Property.
See the difference?
Assumptions are usually appropriate for buyers who intend to stay in the property for a while. "Subject to" transactions, by contrast, are usually entered into by investors who want to quickly flip the property to a new buyer (perhaps doing some rehab work first) and making a profit – without incurring any responsibility for the note in the process.
Can title insurance be obtained on an assumption transaction for which lender approval was not obtained?
Usually not. Title companies are conservative institutions that tend to avoid potential liability at any cost – so such assumptions will likely have to be closed in the office of an attorney familiar with "creative transactions." If the buyer is curious about the status of title, then a title report (not the same as insurance) can always be obtained at modest cost.
What if there is more than one existing loan – an 80-20 for example?
It is not uncommon for a buyer to assume more than one note (e.g., a first and second lien). The notes may even be to different lenders. The principle is the same.
What documents are involved in an assumption?
There are two options here: the first includes security for the seller, i.e., the right to foreclose upon the buyer and take the property back if the buyer does not comply with the terms of the assumption. In this case, necessary documents are a warranty deed with vendor´s lien and a deed of trust to secure assumption. Additional documents – a separate assumption agreement, a property management letter to be sent to the lender, and a power of attorney in favor of the buyer – may be included. These supplementary documents are advisable, if for no other reason than in the future it may be necessary for the buyer to inquire about the payoff on the loan – and without legal authority (i.e., a document signed and acknowledged by the original borrower) the lender will not supply this confidential information.
The second (simpler) option applies where the seller does not require (or perhaps even care about) taking security for the assumption. This might be true if the seller´s credit is already in poor shape. The seller may just want to sign the property over to the buyer and (hopefully) never hear another word about it. In this case, one document – an assumption deed – is sufficient to complete the transaction. Again, however, a property management letter or power of attorney is advisable if it is anticipated that payoff information from the lender will be needed in the future.
What if the buyer defaults on the assumption?
If the seller received a deed of trust to secure assumption at closing, then this enables the seller to foreclose if the buyer defaults. Texas is fortunate to have an expedited non-judicial foreclosure process. Property Code Sec. 51.002 requires that a homeowner be given at least a 20 day notice of default and intent to accelerate the note if the default is not timely cured. See our other articles relating to the foreclosure process for details.
If the seller merely signed an assumption deed without a vendor´s lien and without a deed of trust to secure assumption, then the seller is out of luck.
Challenging economic times occasionally call for "creative" measures when it comes to real estate transfers. An assumption can be an effective option under the right circumstances. Care must taken, however, with the documentation. Consult a real estate attorney familiar with assumptions.
Information in this article is proved for general educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. This firm does not represent you unless and until it is retained and expressly retained in writing to do so.
Copyright © 2012 by David J. Willis. All rights reserved worldwide. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his web site, http://www.LoneStarLandLaw.com