Assumption Transactions in Texas

Topics Covered

Assumable Versus Non-Assumable Loans
Buyer’s Liability on the Existing Note
Due-on-Sale Issues
Creative Approaches to Assumptions
Assumption Documentation
Default by the Assumption Buyer

Features of an Assumption

The features of an assumption are: (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; (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; (3) the original borrower may or may not be released from the assumed note, and (4) the deed of trust lien against the property may or may not remain in place.

Documentation can include a formal assumption agreement. Also, a buyer may want written authority—either a special power of attorney or a property management letter—that allows the buyer to obtain future payoff information.

Assumption documentation may be minimalist (a bare assumption deed) or more comprehensive with several documents involved.

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.

The majority of real-world 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 issue of lender approval arises in the context of whether or not the lender will choose to exercise its option to accelerate the note pursuant to the due-on-sale clause, described below. This is not a mandatory outcome.

Assumable Versus Non-Assumable Loans

In the past there were so-called “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. These are rare now. 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 original borrower off the hook for the debt and substitute the name of the buyer as the new borrower? The answer is usually (but not always) no. Lenders usually 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.

Effect of Title Transfer on Existing Loan

A title transfer by general or special warranty deed does not relieve the original borrower 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.

The only way the buyer becomes obligated to the existing lender is to sign a note to that lender. Similarly, the only way one is released from an existing note obligation is for the lender to sign a release of note and lien.

If the lender is involved in the assumption, one can expect that a formal assumption agreement will be part of the required documentation.

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 response or action.

There is no stated penalty for failing to give the Section 5.016 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 notice statute.

DUE-ON-SALE ISSUES

Lender’s Option to Act

When there is a due-on-sale clause in an existing deed of trust, the lender is given the option to accelerate the note if title is transferred without the lender’s prior consent. Under the typical residential due-on-sale clause, lender action is entirely discretionary. The lender can choose 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 any 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 examined.

Breaching or Violating the Due-on-Sale Clause

If an owner transfers title without lender consent, is he or she violating or breaching the deed of trust? No. In nearly all residential cases, a change of title without notifying the lender is not a breach or violation of anything. It is simply a means of giving the lender a choice. Again, always check the deed of trust to verify how the clause is worded.

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 respond by exercising (or not exercising) its right of acceleration under the due-on-sale clause. Most lenders choose not to accelerate so long as the loan remains current and performing; 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 eliminates the due-on-sale risk. This includes investor land trusts.

ASSUMPTION DOCUMENTATION

Suggested Custom Assumption Addendum

At the contract stage, one should use the TREC 1-4 contract with the Loan Assumption Addendum attached. However, this addendum is minimalistic and usually insufficient to cover all details involved in a creative assumption.

To thoroughly address all the details of the parties assumption agreement, it is recommended that a customized assumption addendum prepared by an attorney be attached to the contract. This should be attached alongside (not instead of) the TREC Assumption Addendum and include the many potential deal points and disclosures that the TREC addendum simply does not mention.

Documents Favoring the Seller

Assumptions (like nearly all real estate matters) are not neutral both-sides-treated-equally transactions. There are no standard forms. The legal documents can significantly favor one side at the expense of the other.

Seller-oriented assumption documents aim to establish a seller’s 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 special power of attorney in favor of the buyer—may be appropriate.

If the seller merely signed an assumption deed without a vendor’s lien and without a deed of trust to secure assumption, the seller is 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.

Documents Favoring the Buyer

Documentation oriented toward an investor-buyer can be much simpler, often consisting only of an assumption deed. The one document is all that is required and there are no default remedies for the seller. This often happens when a seller just needs immediate cash and is unconcerned about any future default or due-on-sale action by the lender.

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.

Elements of an Assumption Agreement

If a formal assumption agreement will be drafted, there are basic elements that should be included:

(1) The assumption agreement should recite the existing parties and describe the loan documents that are currently in existence (the note, deed of trust, and any loan agreement).

(2) The lender agrees to permit assumption of the note by the new borrower so long as certain conditions are met.

(3)The validity, enforceability, and priority of the assumed note is affirmed, and both the original and the new borrower states that there are no defenses, offsets, or counterclaims against enforcement of the note or lien.

(4) The new borrower unconditionally assumes and promises to pay the unpaid balance of the loan and to abide by the terms of the deed of trust.

(5) The date on which the new borrower’s obligation will begin is specified.

(6) A declaration is made that the existing deed of trust is deemed to be modified to reflect the details of the assumption, including the name of the new borrower.

(7) If the original borrower will be released from liability on the assumed note, then the assumption agreement should so state.

(8) Disclosure should be made the assumption does not release the property from the lien imposed by the assumed deed of trust.

If a release of lien will be granted by the lender then the process should end with a recordable Release of Note and Lien of the original borrower’s obligation under the assumed note.

Buyers’ 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 the transaction. The following is a ranking of options from most to least desirable:

(1) take title to the property by means of a simple “subject to” deed (which is not truly an assumption at all) and reject any further documentation;

(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—which means that 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 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.”

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 (1) a custom assumption addendum to the earnest money contract and (2) 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. In this way, the seller might feel safer about selling on an assumption while the buyer limits liability on the assumed note to a short-term payment obligation.

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 note—the 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 wraparound and the wrapped obligations coexist.

In an assumption, no new note is created. The buyer instead makes a promise to the seller (usually not also to 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 sub2 transaction is usually entered into by investors who want to do a short-term flip (perhaps after doing 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.