What is an assumption?
The essential features of an assumption are that the buyer (1) takes title to property by assumption deed (usually with a vendor’s lien) that contains either general or special warranties; and (2) promises to pay the balance of the indebtedness being assumed, a promise that may or may not be secured by a deed of trust to secure assumption (which gives the seller a non-judicial foreclosure remedy in the event of default).
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 can obtain payoff information upon resale.
Having said the foregoing, there are assumptions and there are assumptions, meaning that there are minimalist approaches that incur the least potential liability for the investor-buyer; and there are fully-secured approaches that maximize protection for the seller.
Is the lender’s permission required for an assumption?
No. An assumption may be accomplished with or without consent of the lender. What is an assumption, after all? Merely a title transfer (in which the lender has no participation) and a promise to take over payments on an existing debt. This promise is between buyer and seller. So there is no point in the assumption process where a lender can intercept and prevent the deal, nor is there a means by which a lender can command that an assumption be unwound.
Although a due-on-sale risk may exist if title to property is transferred without lender consent (which remains small so long as the note is kept current), the vast majority of assumptions occur “unofficially,” that is, without consent from the lender.
What about the assuming buyer’s liability on the assumed note? There is none, at least to the lender. Promising to pay the assumed indebtedness is 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 the obligation to pay a note is for the lender to cancel the note and sign 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 contrasted with certain loans in years past that could be assumed merely by paying an assumption fee and notifying the lender of the new owner.
But is the term “non-assumable” accurate? Not really. As stated earlier, the concept of title is separate from the concept of debt. An owner of property is normally entitled to transfer title whenever and to whomever he or she wishes. Doing so, however, does not relieve the seller from responsibility to pay the note (since the seller signed it), nor does it automatically obligate the buyer to pay the note (since the buyer did not sign it). A typical 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, will the lender let the seller off the hook for the debt and replace him under the note with the borrower? The answer is usually no. Lenders want the buyer to apply, qualify, pay fees, and get a new loan. That is, after all, the nature of their business.
More about the Due-on-Sale Clause
If an owner transfers title without consent, has the owner breached the covenants of the deed of trust? Committed an illegal act? No, at least not under the commonly-used FannieMae deed of trust. Lenders would of course prefer to be notified if a loan is going to be assumed by a third party, so they can impose costs and conditions to their benefit-and, in fact, the seven-day notice rule in Property Code Section 5.016 applies for this purpose, but without any stated penalty. The practical result is that in a post-transfer scenario lenders are generally left with only an option to accelerate-a choice not an obligation-and, as noted, this rarely happens when payments are kept up to date. What would your business decision be if you were a lender? Foreclose on a performing loan merely because there was a change in title? Maybe, but probably not.
Is an assumption the same thing as a wrap?
No. In a wrap, a new debtor-creditor relationship between seller and buyer is created. The buyer becomes obligated to the seller on a new wrap note secured by a new wrap deed of trust. The wrap note is the key: no wrap note, no wrap. As to the existing note (which is “wrapped”), 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, the buyer expressly assumes responsibility for paying the existing note. There is usually no new note (unless, for instance, there is a short-term subordinate note executed for part of the down payment).
What is the difference between an assumption and a “subject to” transaction?
In an assumption, the buyer promises to pay the existing debt. By contrast, in a “subject to” deal, 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. The buyer might make payments or might not. This is a typical assumption clause 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 Official Public Records of Real Property 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 Official Public Records of Real Property 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 appropriate for those who intend to hold a property for a while. “Subject to” transactions, however, are usually entered into by investors who want to do a short-term flip to a new buyer for a quick profit, perhaps after doing some rehab work first, without incurring any responsibility for the existing note in the process. The objective is to sell the property to a new buyer who will then pay off the note.
Can title insurance be obtained on an assumption transaction for which lender approval was not obtained?
Sometimes but usually not. Title companies are conservative institutions that avoid potential liability, so most assumptions will need to be closed 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 title, then a title report (cheaper than title insurance) can always be obtained.
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 payable to different lenders. The principle is the same, only the assumption deed will recite that the buyer is now obligated to pay two notes rather than one.
The more complicated the assumption, the more important it is to have a separate assumption agreement which covers the details.
Can an investor-buyer make a limited agreement to pay the note until the house is flipped?
Yes. This is an interesting hybrid, not a true assumption but not a true “subject to” either. An investor-buyer may (either in the deed from the seller or in a side agreement) contractually agree with the seller to make loan payments for a limited time-say, a year, or perhaps until the property is resold to a third party. The wording might look like this: “Although buyer does not formally assume any legal obligation to pay the existing indebtedness, it is agreed between buyer and seller that buyer will commence making monthly payments directly to the lender on _____, 20___ and continue timely making such monthly payments for a period of up to 12 months or when the property is resold to a buyer who discharges the existing indebtedness, whichever is less.” In this way, the seller may feel safer about doing the deal, while the investor-buyer has effectively limited his or her liability.
What documents are involved in an assumption?
At the contract stage, one should use the TREC 1-4 contract with the Loan Assumption Addendum attached. This Addendum unfortunately does not have a special provisions section that would allow for creative approaches discussed in this article, so customization by an attorney may be necessary.
Post-contract, there are two approaches to the documentation: the first is seller-oriented, since it includes security for the seller, namely the right to foreclose upon the buyer non-judicially and take the property back if the buyer does not comply with the assumption terms. 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 payoff, and without legal authority (i.e., a document signed and acknowledged by the original borrower) a lender will not supply this confidential information. An effective alternative might be to obtain the seller’s online login information so as to access the lender’s website.
The second, simpler documentation option is more favorable to an investor-buyer. It is used when 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 an investor and never hear another word about it. For this option, one document-an assumption deed-is sufficient to transfer title and complete the transaction. This should always be an investor-buyer’s preferred approach. Quick, simple, and easy.
What if the buyer defaults on the assumption?
If the seller received a deed of trust to secure assumption at closing, then the seller may foreclose on the courthouse steps if the buyer defaults. 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.
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, then the seller is out of luck when it comes to a quick remedy. Even if the seller did not get a deed of trust to secure assumption for the buyer, the seller may foreclose on the vendor’s lien retained in the deed-but this is a judicial process (a lawsuit), not something that can be accomplished expeditiously on the courthouse steps.
Order of Preference-Creative Approaches to Assumptions
From the point of view of an investor-buyer, there is a definite order of preference when it comes to structuring and documenting assumptions:
1. take title to the property by means of a “subject to” deed, which is of course not an assumption at all;
2. take title by means of a hybrid deed-basically a sub2 deed which promises to assume payments for, say, six months, or perhaps until the property is re-sold-so the assumption portion of the document is strictly limited in duration;
3. take title by means of a stand-alone 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 assume the entire existing debt, and then begin making monthly payments on a certain date, creating a contractually enforceable promise on the part of the buyer to the seller to fully pay the assumed indebtedness;
4. take title by means of a stand-alone assumption deed with a vendor’s lien (and unsupported by a deed of trust);
5. Take title by means of an assumption deed with vendor’s lien, secured by a deed of trust to secure assumption, and supported by an assumption agreement along with a special power of attorney in favor of the buyer (for purposes of dealing with the lender)-all of which incur or increase the possibility of foreclosure in the event of buyer default.
Understand that every real estate investment entails an element of risk. Otherwise, why would there be a reward? Sensible risk management means tailoring each transaction so as to maximize the potential for a positive return while minimizing the downside. Here is just one example: every transaction in which debt is involved should ideally include a non-recourse clause against the general assets of the investor debtor. Memorize these words and repeat them like a mantra to your lawyer: non-recourse clause. Such an approach requires intelligent customizing of documents and is another reason to avoid forms from the Internet or anywhere else.
Information in this article is provided for general informational and 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 expressly retained in writing to do so.
Copyright © 2019 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 website, www.LoneStarLandLaw.com.