What is an assumption?
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 pay all or part of the balance of existing indebtedness against the property, a promise that may or may not be secured by a deed of trust to secure assumption that gives the seller a non-judicial foreclosure remedy in the event of nonpayment.
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 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.
Can an assumption be accomplished without the lender’s permission?
Yes. 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.
As far as a lender’s ability to prevent an assumption transaction, no such mechanism exists. There is no point in the process where a lender has the legal ability to intercept and prevent the assumption transaction from closing, nor is there a means (judicial or non-judicial) by which a lender can require that a completed assumption transaction be unwound.
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 make 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.
Buyer’s Liability on 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.
Assumable Versus Non-Assumable Loans
Most loans today are referred to as non-assumable. This is contrasted with certain loans in years past (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, does the term non-assumable mean that an owner cannot deed the property to someone else? No. The concept of title is separate from the concept of debt. An owner of real property is normally entitled to transfer title whenever and to whomever he or she wishes. Doing so, however, does not relieve the selling owner from responsibility to pay the existing note (since the seller has not been released) nor does it obligate the buyer to start making payments on the note (since the buyer has not signed the lender’s note). A typical deed transfers title—that’s all. Obligations to a lender under existing indebtedness remain exactly as they were before the sale.
The assumability issue is relevant only in determining whether or not the lender will allow 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 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.
Before engaging in an assumption without lender consent, one should 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.
The due-on-sale clause in paragraph 18 of 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. . . .” A lender is thus given the option to accelerate the note if it chooses. Lender action is entirely discretionary.
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. . . .”
Most residential deeds of trust merely give the lender a choice as to whether to accelerate the note or not. It becomes a business decision by the lender to either (1) take no action or (2) accelerate and proceed to foreclosure. For now, the majority of lenders are choosing not to accelerate so long as the loan remains current; but there is always the possibility that economic factors (rising interest rates, for example) could influence lenders to make a different choice. There is no method of doing an assumption transactions that eliminates the due-on-sale risk.
Additional note: if an owner transfers title without lender consent, is he or she guilty of breaching the deed of trust? Committing an illegal act? No. In nearly all residential cases, a change of title without notifying the lender is not a breach or violation of anything. It only results in giving the lender a choice as to whether or not to accelerate. It does not render the owner civilly or criminally culpable in any way.
Seven-Day Notice Rule
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. There is, however, no stated penalty for failing to give the notice.
In most cases when this notice is given (often to the loan servicer) there is no immediate response or action.
Lender consent is not required under this statute.
Is an assumption the same thing as a wrap?
No. In a wrap, 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 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?
Sometimes but 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.
What if there is more than one existing loan?
An assumption transaction may still occur if there are 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 will 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, 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 12 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.
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 allows for creative approaches, so a customized special provisions addendum prepared by an attorney will almost certainly be necessary as well.
As to the closing documents, there are two approaches:
(1) Seller-Oriented. 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.
(2) Oriented in Favor of Investor-Buyer. The second, simpler 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. If the seller’s credit is already in poor shape, the seller may just want to deed the property over to an investor-buyer and hope to never hear any more about it. For this approach, a single document—an assumption deed without a vendor’s lien—is sufficient to complete the transfer title. Getting a simple assumption deed like this should always be an investor-buyer’s preferred approach.
What if the buyer defaults on his promise to pay the existing note?
If the seller obtained security in the form of a deed of trust to secure assumption—option (1) 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 for buyer default. In the absence of actual fraud committed by the buyer, the seller is probably out of luck entirely.
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 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.”
From the point of view of an investor-buyer, the closing documents for every transaction in this category—one that involves a title change where there is existing debt—should as a safety measure include a non-recourse clause against the general assets of the investor debtor.
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 © 2023 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.