Assumption Transactions in Texas

Introduction

The essential features of an assumption are that: (1) the buyer takes title by means of an assumption deed (with or without a vendor’s lien retained by the seller) containing either general or special warranties; and (2) the buyer promises to the seller to pay all or part of the balance of an existing note against the property, a promise that may or may not be secured by a deed of trust to secure assumption.

Additional documents such as an assumption agreement may also be needed. If the buyer is an investor, some sort of authority—either a special power of attorney or a property management letter—should be secured so that the investor-buyer can later obtain payoff information.

In terms of transactional documentation, there is a barebones unsecured approach that minimizes potential liability for a buyer, and there is a secured approach (involving a vendor’s lien and deed of trust to secure assumption) that maximizes protection for the seller.

Does an assumption require the lender’s permission?

No. An assumption transaction may be accomplished with or without consent of the lender. The transaction involves only a title transfer (a conveyance by deed in which the lender does not participate) and a promise by the buyer to take over payments on an existing debt. This promise is between buyer and seller and does not involve the lender on the existing loan.

The majority of assumption transactions occur unofficially without consent from the lender. Title is transferred and the buyer makes a promise to the seller that he or she will assume payments on the existing note as they fall due. The specifics of how payments will be handled and when they will begin is often handled in a separate assumption agreement between buyer and seller.

Assumable Versus Non-Assumable Loans

In the past there were “assumable loans” (VA loans, for instance) that could be assumed just by paying an assumption fee and notifying the lender of a new owner. It was a simple substitution.

Those days are gone. Even so, the terms assumable and non-assumable linger in today’s real estate parlance.

If a loan is considered to be non-assumable, does that mean that the property cannot be deeded to someone else? No. The concept of title is separate from the concept of debt. An owner of real property may transfer title whenever and to whomever the owner wishes.

The assumability issue is relevant only in determining whether or not the lender will allow formal substitution of one borrower for another. In other words, will the lender let the seller off the hook for the debt and substitute the name of the buyer as the new borrower? The answer is usually no. Lenders want a new buyer to either (1) apply, qualify, and pay fees to assume the existing loan or (2) get a new loan. That is the nature of the lending business.

Reminder: a title transfer does not relieve the selling owner from responsibility to pay the existing note (since the seller has not been released) nor does it create an obligation on the part of the buyer directly to the lender.

A typical deed transfers title—that’s all. If the deed recites assumption obligations between the parties then these obligations are between the parties only. They do not bind the lender or affect the lender’s recourse or remedies in event of default in payment of the existing note.

Buyer’s Liability on the Existing Note

After the assumption is closed (assuming lender pre-approval was not obtained), what is the buyer’s liability to the lender on the existing note? There is none. Promising to pay the existing indebtedness in an assumption transaction is only a pledge from buyer to seller, not to the lender.

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 a note obligation is for the lender to sign a release of note and lien.

Seven-Day Notice to the Lender

Property Code Section 5.016 contains a notice rule that applies in the case of unapproved assumptions. This section requires that seven-days advance notice be sent to the lender, theoretically providing the lender with an opportunity to call the loan due. In most cases when this notice is given (often to the loan servicer) there is no immediate response or action.

There is no stated penalty for failing to give the notice. Failure to provide the lender with advance notice does not invoke any additional remedies that a lender may employ.

Lender consent is not required under this statute.

DUE-ON-SALE

Lender’s Option to Act

When there is a due-on-sale clause in the existing deed of trust, the lender is given the option to accelerate the note if it chooses. Lender action is both responsive and discretionary.

Most residential deeds of trust merely give the lender a choice as to whether to accelerate the note or not. The due-on-sale clause in the commonly-used FannieMae deed of trust states: “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 [italics added] require immediate payment in full. . . .”

The due-on-sale clause in the FHA deed of trust is worded differently. Paragraph 9(b) states that the lender “shall [italics added], if permitted by applicable law . . . require immediate payment in full. . . .”

Before engaging in an assumption without lender consent, it is prudent to check the wording of the deed of trust securing the existing loan. If it contains a due-on-sale clause (and nearly all of them do) then its wording needs to be carefully evaluated.

Breaching or Violating the Due-on-Sale Clause

If an owner transfers title without lender consent, is he or she guilty of breaching the deed of trust? Or committing a prohibited or illegal act? No. In nearly all residential cases, a change of title without notifying the lender is not a breach or violation of anything. That is not how a due-on-sale clause is usually worded. A title transfer without prior consent results only in giving the lender a choice as to whether or not to accelerate and demand full payment of the existing note. The assumption seller is not civilly or criminally culpable in any way.

Responsive Action by the Lender

There is no point in the process where a lender has the legal ability to intercept and prevent an assumption transaction from occurring, nor is there a means (judicial or non-judicial) by which a lender can require that a completed assumption transaction be voided or unwound. The lender can only be responsive in an assumption situation by exercising its right under the due-on-sale clause to accelerate the note, if it chooses to do so.

When a title transfer takes place, the burden to act falls upon the lender, who must make a business decision to either (1) take no action or (2) accelerate and proceed to foreclosure. Most lenders choose not to accelerate so long as the loan remains current; but there is always the possibility that other factors (rising interest rates, for example) could influence a lender to make a different choice.

Other than maintaining the existing note in current status, there is no method of doing an unapproved assumption that mitigates or eliminates the due-on-sale risk.

CREATIVE APPROACHES TO AN ASSUMPTION

What if there is more than one existing loan?

An assumption transaction may involve multiple loans and liens. The notes may even be payable to different lenders. A buyer may agree to assume payment of existing first and second liens, for example. The assumption deed may recite that the buyer is promising (to the seller) to make payments on two notes rather than one. The more complicated the assumption, the more important it is to have a stand-alone assumption agreement that covers the details.

What about a short-term agreement to pay the note?

This is a hybrid, not a true assumption but not a true sub2 transaction either. An investor-buyer may make a promise to the seller to assume payments on the existing loan for a limited time—a year, perhaps, or until the property is resold to a third party. This is certainly feasible but the legal wording can be tricky. Example:

Although buyer does not promise to pay the existing note in full, it is agreed between buyer and seller that buyer will nonetheless make a limited number of monthly payments on said note commencing [date] and continuing for a period of up to ____ months or when the property is resold to a buyer who discharges the existing note, whichever is less.

In this way, the seller may feel safer about selling on an assumption while the investor-buyer limits liability to a short-term payment obligation.

ASSUMPTION DOCUMENTATION

The Contract Stage

At the contract stage, one should use the TREC 1-4 contract with the Loan Assumption Addendum attached. However, this addendum is usually insufficient to cover all details involved in a creative assumption, so a customized assumption addendum prepared by an attorney will almost certainly be necessary as well. Involve an attorney early in the process, before the contract is signed.

As with many creative transactions, it is nearly always best to begin with a letter of intent.

Documents Oriented toward the Assumption Seller

There are two general approaches to assumption documentation. The first approach is seller-oriented since it includes security for the seller, namely the right to foreclose and take the property back if assumption terms are not complied with. Documents required 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 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 it may become necessary for the buyer to inquire about a payoff, and without evidence of legal authority (a document signed and acknowledged by the original borrower) a lender will not supply this confidential information. An alternative might be to obtain the seller’s online login information so as to access the lender’s website.

Documents Oriented toward the Assumption Buyer

This simpler, unsecured assumption option involves only a deed transferring title without any accompanying deed of trust. Getting a simple assumption deed like this should always be an investor-buyer’s preferred approach. It often happens when a seller just needs immediate cash and is unconcerned about future due-on-sale action by the lender.

Documentary Order of Preference

From the point of view of an investor-buyer in an assumption, there is a definite order of preference when it comes to structuring and documenting these sorts of transactions:

(1) take title to the property by means of a “subject to” deed (which of course is not an assumption at all);

(2) take title by means of a hybrid deed—basically a sub2 deed that promises to make payments on the existing note for a limited period (six months for example) or until the property is resold—so the assumption portion of the transaction is strictly limited in duration;

(3) take title by means of an assumption deed without a vendor’s lien (and unsupported by a deed of trust) which promises, as part of the consideration for the transfer, that the investor-buyer will pay the existing debt with payments commencing on a certain date;

(4) take title by means of a stand-alone assumption deed with a vendor’s lien (but without a deed of trust to secure assumption in favor of seller); or

(5) take title by means of an assumption deed with vendor’s lien secured by a deed of trust to secure assumption in favor of the seller and supported by an assumption agreement along with a special power of attorney (to enable the buyer to communicate with the lender).

The guidance of an attorney experienced in this area should always be obtained in preparing documents, since it can be easy to mix or confuse assumption language with language relating to “subject to.”

ASSUMPTIONS VERSUS
OTHER CREATIVE TRANSACTIONS

Is an assumption the same thing as a wrap?

No. In a wraparound, a new borrower-lender relationship is created, one between buyer and seller. The buyer becomes obligated to the seller on a new wraparound note that is secured by a new wraparound deed of trust. As to the existing note (the wrapped note), the seller remains obligated to continue monthly payments until it is paid and released. The wrap and the wrapped obligations coexist.

By contrast, in an assumption, no new note is created. The buyer instead makes a promise to the seller (not the lender) that the buyer will pay the existing note.

What is the difference between assumption and “subject to?”

In an assumption, the buyer promises to pay the existing debt. By contrast, in a sub2, the buyer takes title but expressly disclaims any obligation to pay the seller’s debt, even though that debt is secured by an existing lien on the property. There is no agreement to assume anything. A sub2 buyer can choose to keep the existing loan current or not.

A typical assumption clause in a deed might read: “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 Assumed Deed of Trust. Grantee shall commence payments on the Assumed Note on or before the next regular due date under the Assumed Note.”

A typical “subject to” clause might read: “This conveyance is made subject to any and all indebtedness of Grantor and liens against the Property including but not limited to that certain note described as follows: [details of note]. Grantee does not assume payment of this or any other indebtedness of Grantor.”

A sub2 transaction is usually entered into by investors who want to do a short-term flip (perhaps after doing some rehab work) without incurring any responsibility for the existing note in the process. The objective is usually to sell the property quickly to a new buyer who will then pay off the existing note at a traditional title company closing.

Assumptions tend to be more appropriate for those who intend to hold a property for a while.

Is title insurance available for unapproved assumptions?

Usually not. Title companies are conservative institutions that avoid potential liability so most assumptions will need to be closed without title insurance in the office of an attorney familiar with creative transactions. If a buyer is curious about the status of title (and an investor-buyer should always be curious about the chain of title) then a title report should be obtained and examined before closing.

DEFAULT BY THE ASSUMPTION BUYER

Remedies for the Assumption Seller

What can the seller do if an assumption buyer defaults? If the seller obtained security in the form of a deed of trust to secure assumption (the first option above) then non-judicial foreclosure (on the courthouse steps) is available if the buyer defaults on the assumption promise. Texas has an expedited non-judicial foreclosure process set out in Property Code Section 51.002. This statute 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. A judicial foreclosure (by means of a lawsuit) is also an available option.

If, on the other hand, the seller merely signed an assumption deed without a vendor’s lien and without a deed of trust to secure assumption, the seller is probably out of luck when it comes to a quick remedy if the assumption buyer defaults. The only real option is a generic lawsuit for breach of contract.

Non-Recourse Clause

The investor-buyer in an assumption transaction should always seek to include a non-recourse clause in the documentation. This can prevent a seller from exercising remedies that extend beyond the subject property.