Charles J. Jacobus

TEXAS REAL ESTATE LAW 11E

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Chapter 13

Mortgages

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Mortgages

• The financing of real estate is one of the key factors in the ability to consummate a sale.

• Any real estate agent who understands the various methods of financing real estate has a clear advantage over his competitors.

• Many deals are contingent upon the purchaser obtaining financing.

• To understand these financing one must also understand the basics of the various types of mortgages in Texas.

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Instruments

Most mortgage procedures in Texas require two instruments: the promissory note and the deed of trust.

The promissory note is the actual promise

to pay.

The deed of trust pledges the real

property as collateral.

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Real Estate Lien Note

Contains the actual promise to pay along with:

The real estate lien note is normally not a recorded instrument since it does not create the lien interest in the real estate.

The lien interest is created by the mortgage instrument.

[1] the amount [2] the interest rate [3] provisions for past due unpaid principal and interest [4] the term [5] payment clause [6] prepayment clause[7] default clause[8] payment of attorney’s fees in the event legal proceedings[9] waiver of notice for payment, and waiver of notice to accelerate [10] security clause[11] legal description of the collateral[12] signatures of the makers of the note

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Deed of Trust

• The mortgage is the document that offers the property as security.

• The most commonly used mortgage in Texas is the deed of trust.

• A deed of trust is a three-party mortgage with a power of sale.

• Legal title does not pass in a deed of trust. The lender gets only a lien.

• Borrower conveys property to a 3rd party trustee as security for a loan.

• When the note is paid in full, the deed of trust renders the conveyance to the trustee null and void. This is called the defeasance clause.

• The more common practice, however, is to file a release of lien.

• Trustor (borrower) – Trustee (third party) – Beneficiary (lender)

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Requirements

Five requirements that make a deed of trust legally enforceable in Texas.

1. Granting clause and property description 2. Habendum and warranty clause 3. Trust clause 4. Note and debt provision 5. Power of sale clause

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Granting Clause and Property Description

• Defines the grantor (this is the grantee of the deed—and purchaser of the property).

• The clause effects a conveyance, in trust, of the described real estate.

• True legal title does not pass to the trustee, only title sufficient to create an interest in the property, in the event of a default.

• There is a legal description of the real estate.

“Borrower irrevocably grants and conveys to Trustee, in trust, with power of sale, the following

described property…..”

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Habendum and Warranty Clause

The habendum and warranty clause is very similar to that of a deed, as discussed in Chapter 10, and basically binds the grantor to the warranty, so that his legal title in the real estate is good and sufficient.

BORROWER COVENANTS that Borrower is lawfully seised of the estate hereby conveyed and has the right to grant

and convey the Property and that the Property is unencumbered, except for encumbrances of record.

Borrower warrants and will defend generally the title to the Property against all claims and demands, subject to any

encumbrances of record.

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Trust Clause

• Sets out that this conveyance is made in trust to secure the payment of the promissory note.

• This limits the title that is being passed and clearly sets out the trust relationship and reinforces the limited nature of the conveyance.

• Does not create a true trust, it only creates an enforceable right in the trustee in the event of a default.

This Security Instrument secures to Lender: (i) the repayment of the Loan, and all renewals, extensions and

modifications of the Note; and (ii) the performance of Borrower’s covenants and agreements under this Security

Instrument and the Note. For this purpose, Borrower irrevocably grants and conveys to Trustee, in trust, with

power of sale, the following described property

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Note and Debt Provision

• Indicates the amount of the note and defines the beneficiary (lender).

• The terms of the note may be specified in this provision.

• The words “as therein provided” are often used as sufficient reference to the terms of the note.

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Power of Sale Clause

• Makes the deed of trust unique when compared with other mortgages.

• Provides for an out-of-court foreclosure in the event of a default.

• Must comply with the Texas law pursuant to sales under a deed of trust.

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Notice of Sale – Generally

• Trustee will post notice at the courthouse and the county clerk’s office. • The notice must state the earliest time the sale will begin. • Sale must take place within three hours after posted time.• Copy must be sent (certified mail) to the grantor’s last known address. • If the grantor’s residence, notice is preceded by a 20-day notice to

cure. • Notice to the husband and wife can be sent to only one of them.• The notice must be posted at least 21 days preceding date of the sale. • The day the notice is posted is the first day of the required time period.• Sale is always on the first Tuesday of the month following the notice. • Anyone is allowed to purchase , including the grantor or the lender. • Cash sale to highest bidder and paid at the time of auction.• Trustee can give a “reasonable” time to provide the cash.• The sale is held between 10:00 a.m. and 4:00 p.m.. • Sale must be held in area designated by the county commissioners.• Conveyance is made by use of a trustee’s deed. • Title is passed subject only to superior interests, if any.

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Notice of Sale – Debtor

• Notice must not be given to anybody who is not a debtor and need not be given to a debtor against whom no deficiency is sought.

• The purpose behind the notice requirement is to give each debtor an opportunity to protect his own interest.

• Anybody who purchases the property subject to the mortgage would not be entitled to the notice in the event of a foreclosure.

• The statute only provides a minimum level of protection for the debtor.

• If lender has no knowledge of debtor’s whereabouts, there is no obligation to search for the address if none is shown in his records.

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Foreclosure on Active Duty Military

• If a service member’s ability to comply with their mortgage is materially affected by his or her service, they are entitled to stay any foreclosure for a period of time as justice and equity require, or can adjust the obligations of the contract to preserve the interest of all of parties.

• He or she merely has to submit to a court hearing.

• In order for the adjustments to be made, the request must be:1. in writing, in at lease 12 point type.2. executed as a separate agreement.3. made under a written agreement executed during or after

the service member’s period of active duty military service, and specifying the reason for the adjustment.

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Inadequate Price

• Lenders used to sell at inadequate price & seek a deficiency judgment.

• If an irregularity is present the sale may be set aside. Examples include:1. Auction was not called loud enough.2. Debtor fooled into thinking sale would not take place.3. Less than all of the property could be sold to satisfy the debt.4. Trustee “chilled” the sale.

• Lender may pursue a deficiency against the borrower within two years.

• The borrower may challenge the price paid at the foreclosure sale.

• A judge or jury determines whether or not market value was paid.

• Court may offset debt by the market value instead of foreclosure price.

• Monies from private mortgage insurance must be credited as well.

• PMI company may then pursue a deficiency against the borrower.

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The Deed-in-Lieu Statute

• Borrowers may want to avoid the embarrassment of public foreclosure.

• Borrower will simply deed the property back to the lender to avoid.

• But lender does not acquire the same rights as in foreclosure.

• Lender may void such deed within four years if: (1) the debtor fails to disclose to the holder of the debt a lien before executing the deed. (2) the holder of the debt has no knowledge of the undisclosed.

• If the lender voids the deed-in-lieu of foreclosure, the priority of its deed of trust will not be affected.

• As an alternative, the lender can accept the deed-in-lieu of foreclosure but still foreclose on its deed of trust without electing to void the deed.

• Allows lenders to preserve a little dignity for a borrower and not pursue a public foreclosure.

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Redemption

• When the borrower has the right to bring the payments up-to-date even after the foreclosure, and reacquire title to the property.

• In Texas there is no right of redemption unless granted in the note.

• An old common law doctrine has always existed in Texas that created an equity of redemption before foreclosure.

• To enforce an equity of redemption: (1) the party must prove a legal or equitable interest in the property. (2) be “ready, able, or willing to paying off the liens. (3) assert his equity of redemption before the foreclosure sale.

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Lien Priority

• When a valid foreclosure sale under by a deed of trust takes place, all other lien interests that are inferior are wiped out.

• If the foreclosure sale is invalid, the person who bids for the property on the foreclosure sale does so at his own peril.

• Lien priorities follow the “barber shop rule”; first in time gets priority.

• In the foreclosure process, the purchaser is said to redeem up and the trustee forecloses down, indicating that all the inferior interests are dissolved, and the purchaser acquires the right to pay off the superior interests.

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Additional Deed of Trust Provisions

• One often finds that there are additional provisions in a deed of trust.

• The lender needs to be sure that no additional conflicting claims may arise in his security and that the real estate is kept in good enough condition so that the value of his security is not impaired.

• Provisions include the requirements for payment of all taxes and assessments, requirements to keep the property adequately insured, provisions for a substitute trustee, and provisions for bankruptcy.

• Other common provisions that one may encounter include:• Assignment of rentals• Condemnation• Partial release• Due-on-transfer• No personal liability• Insurance clause

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Why Have Two Instruments?

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Negotiability

• The promissory note is considered a negotiable instrument.

• The note can be sold to an investor, who becomes the new noteholder.

• New noteholder is subrogated to the rights of the previous noteholder.

• New noteholder becomes a holder in due course, taking the note free and clear of all defenses that the maker may have, except for fraud.

• All the endorsers of this note, sometimes including the primary lender, have guaranteed that the payments will be made on the note.

• A mortgagee is not required to give the mortgagor notice of the assignment unless it is covered by RESPA (discussed in Chapter 16).

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Foreclosure

• A promissory note is an unconditional promise to pay.

• Should be no conditions to payment, obligation to pay is absolute.

• Noteholder has the right to accelerate all the payments when one payment is a day late.

• This, in turn, gives him the right to foreclose under the deed of trust.

• True even if the mortgage has not been assigned to the new noteholder.

• Right to foreclose under the mortgage passes to the new noteholder.

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Refinancing

• The separate promissory note also creates other misconceptions.

• For instance, a person frequently talks about refinancing his house.

• In Texas, one cannot refinance above the existing principal balance.

• He merely renegotiates his note to reflect different payments, different interest rate, different term, or other method of payment.

• The note is still secured by the same deed of trust.

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Deed of Trust

• A deed of trust is a mortgage that evidences a lien against the property.

• This is normally recorded to reflect the lender’s interest.

• Lender forecloses on the lien created by the deed of trust and sues on the note for the debt.

• Each serve different functions but are dependent on each other.

• The deed of trust is not a deed – it is a mortgage.

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Other Types of Mortgages

Regular MortgagesAbsolute Deed

Sale Lease-Back Installment Sales Contract

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• A two-party mortgage where the mortgagor offers his property as security and the mortgagee is the lender and holder of the note.

• There is no third-party trustee and there is no power of sale clause.

• Some states have held that a power of sale clause is unconstitutional because it denies the borrower his property without due process of law.

• In most of these other states we find the regular mortgage is common.

• Regular mortgage must be foreclosed through judicial proceedings.

• Texas courts have consistently upheld the power of sale clause under Texas law, so this type of mortgage is seldom used in Texas.

Regular Mortgage

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Absolute Deed as a Mortgage

• Mortgagor gives the lender a deed to the property as a mortgage.

• A transfer of legal title does take effect, but the parties intend the transfer to be security for a loan rather than a sale.

• Grantor retains possession and the market value of the property is in excess of the consideration given for the transfer.

• This is similar to mortgages in title theory states (where the lender is determined to have legal title and the mortgagor merely a lien).

• When the property is fully paid for, the mortgagee executes another deed to reconvey the property back to the original owner.

• Remember that Texas is a lien theory state.

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Sale Lease-Back

• Owner of a property will sell for cash and then simultaneously execute a lease with the purchaser for the use and occupancy of the premises.

• This guarantees a definite rate of return on an investment for the purchaser along with tax advantages.

• Seller receives cash, does not give up possession, and rent is tax deductible.

• If the transaction is not carefully done, or if there is too close a relationship between the buyer and the seller, the IRS may choose to treat the transaction as a loan rather than as a true sale.

Sale Lease

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Installment Sale Contracts

• Provides for seller financing pursuant to the terms of the installment land contract.

• Seller can establish his own criteria in evaluating the purchaser.

• The purchaser buys the house and when he has paid the full number of monthly payments, the seller will convey the property by deed.

• In the event of foreclosure, the contract is simply forfeited and rescinded in the event of default.

• Although there are risks involved for the purchaser, it provides a very efficient means to purchase without having to qualify for a regular loan.

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Construction Mortgages

• The permanent lender promises to pay off the construction lender upon completion.

• The mortgagor then begins making his monthly payments to the permanent lender.

• The interest rate on construction loans is generally higher than that of the permanent loan.

• May include a future advance clause, which secures all sums loaned by the construction lender.

• May include an additional property clause which provides any property attached to the premises also to be secured by the deed of trust.

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Home Equity Mortgages (In Texas)

• The loans can only be made by designated lending institutions.

• Owner can not be required to use the loan to repay a loan to that

lender.

• Owner may not assign wages for the extension of the credit.

• Owner may not sign any instrument which blanks are left to be filled in.

• Owner may not sign a confession of judgment or POA to the lender.

• Lenders required to give copies of all documents signed by the owner.

• Three day right of rescission after the extension of credit is made.

• A written acknowledgment as to fair market value is signed at closing.

• The penalties for non-compliance are severe for the lender.

• Owners & spouses receive a final statement one day prior to closing.

• Any change would delay closing by at least one business day.

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• A pre-approved loan drawn down in increments, repaid in increments, and generally kept open up to an agreed limit.

• Each advance under the line of credit must be at least $4,000 and the lender may not charge any fees with each advance.

• The only fees charged are those collected at the time the line of credit is established.

• The maximum of principal amount that may be extended when added to all other debts secured by the homestead claimant may not exceed 80% of the fair market value of the property on the date the line of credit is established.

• The principal balance under the line of credit, however, may not exceed 50% of the fair market value of the home as determined on the date the line of credit is established.

Line of Credit Loans

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Assumption

• The grantee of the property becomes primarily liable on the note and deed of trust, whereas the grantor in the situation operates as a surety in the event the note is not paid in full.

• If there is a default on the note, the lender must pursue his remedy against the grantee; but if the grantee cannot satisfy the indebtedness, the lender has the remedy of also pursuing a cause of action against the original grantor.

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Subject To

• When property is sold subject to an existing mortgage, the grantee does not become obligated to pay the mortgage but merely has the option of paying that mortgage if he chooses to do so.

• The grantor still remains primarily liable on the note, and the grantee has no obligation at all to the original lender.

• If there is a due-on clause in the original deed of trust, the assumption situation normally cannot take effect until the subsequent grantee has been approved by the lender. This is also true with “subject to”.

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Wraparound Mortgage

• The property is conveyed by a deed “subject to” the existing mortgage, and, of course, the second mortgage between the grantor and grantee is signed by the grantee “subject to,” but not promising to pay, the prior existing mortgage.

• The wraparound mortgage has basically the same effect as creating a second lien deed of trust, except that the obligation of the grantee is to pay the entire mortgage amount to the grantor, and the grantor, in turn, pays the lender.

1 + 1 = 1

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Advantages and Disadvantages of a “Wrap”

• There is normally no outside financing to be obtained by the grantee.

• Avoids risks since the grantee must pay the grantor directly.

• The grantor is always sure that the first lien payments are being made.

• If there is a default , the grantor is immediately on notice forecloses .

• The sale price is normally higher; there is a higher interest yield; and the seller can take an installment sale advantage as a tax benefit.

• Buyer deals with the seller directly.

• Buyer runs the risk that the seller may not pay off the prior lien note(s) and may default.

• This problem can sometimes be overcome by the use of a third-party escrow agent.

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CASE STUDIES FOR DISCUSSION

1. The First National Bank of Dimebachs sought to foreclose on Green Acres Apartment Complex. Upon foreclosure, the contractor arrived to remove all the fixtures he had installed in the premises. The First National Bank of Dimebachs alleged that its deed of trust was prior in time and, therefore, had a prior interest in the fixtures. The contractor claimed he had a right to remove them or recover all severable fixtures because of his claim as a mechanic and materialman, even though his claim was second in time. What legal ramifications do you foresee?

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CASE STUDIES FOR DISCUSSION

2. Mr. and Mrs. Niland owned a large single-family residence on an acre and a half lot in Dallas, Texas. They also owned a condominium in the same general area of town. They went to Lender No. 1 and claimed that their single-family residence was their homestead and used the condominium as security for a loan. They signed a non-homestead affidavit and a designation of homestead for their single-family residence. They then went to Lender No. 2 and claimed the condominium was their homestead and borrowed money using the single-family residence as security for the loan. They used part of the proceeds to pay off Lender No. 1 and then defaulted to Lender No. 2. Upon Lender No. 2’s foreclosure, the Nilands alleged that the house was their homestead, the loan was invalid, and the lender could not foreclose. Lender No. 2 foreclosed and Mr. Deeson bought the property at the foreclosure sale. Mr. Deeson alleges the house is his because he was the purchaser at the foreclosure sale. Mr. Niland alleges the house is his because it was his homestead, and the lender is worried. What legal ramifications do you foresee?

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Questions for Discussion

1. Why should real estate agents know anything about mortgages and lending?

2. Explain the difference between a note and a mortgage.

3. What is a deed of trust, who are the parties involved, and what are their functions?

4. Explain the rights of redemption in Texas.

5. What are some of the specific conditions of a home equity loan under the Texas constitution?