Rule 11 Agreements - Part Two

Rule 11 Agreements in Texas – Unexplored Territory

Part Two

The following list of “principles” concerning Rule 11 Agreements will rehearse some things you already know and maybe a couple of things you did not.

1.      There is no legal status of separation in Texas. One is either married or unmarried.

2.      It is generally agreed that married spouses have an interest in their spouse’s homestead property. This “interest” can rarely if ever be “signed away.” [There is an agreement called “partitioning” that can, somewhat, be used to “pre-partition” community property before final divorce. But, that is another matter and not a strategy we have proposed in financing matters.]

3.      This “interest” that spouses have in homesteaded properties leads many people to (wrongly) conclude that the law requires a spouse to sign the Deed of Trust for his/her spouse’s purchase of another primary residence (as in a case wherein the purchase occurs before final divorce but after petition has been filed).

4.      The fact that there is no legal status of separation, however, does not preclude mortgage underwriting from recognizing what is tantamount to a “separation agreement.”

5.      A Rule 11 suffices for a “separation agreement” AS FAR AS MORTGAGE / FANNIE MAE GUIDELINES ARE CONCERNED. Again, there is no claim that the parties are “legally” separated; only that specific terms of the pending divorce are agreed.

6.      This is critically important because when two parties petition for divorce, this petition ² alerts the lender (which has received a loan application) that several significant features in loan approvals are “up for grabs.” Naturally, a lender cannot discern income, assets and debts if those matters are in negotiation. A final decree of divorce will (almost always) specify all of those issues and enable the underwriter to determine precisely things like income, assets, debts and obligations amongst other important elements.  

7.      Before final divorce, can such features of a loan approval be determined with legal accuracy? Yes. That’s what a Rule 11 can do.

8.      Specifically, Rule 11 Agreements are required (and useful for mortgage underwriting) before a final divorce. Thus, they serve as a “separation agreement” as far as mortgage underwriting is concerned.

9.      Rule 11 Agreements are contractual and NOT ordered by the court that is hearing the divorce cause. Any violation of the Rule 11 would be a legal matter for any procedure that hears or makes judgments about contract law (civil courts, mediators, etc.).

10.  Summary: Rule 11 Agreement function as a “separation agreement” as far as mortgage underwriting and title insuring is concerned but do not propose to establish some legal status of separation.

 

The Unifying Principle

The unifying principle in all of these considerations is that a Rule 11 Agreement is required in mortgage financing for all borrowers who have petitioned for divorce and need to obtain a mortgage loan (for purchasing or refinancing) before final divorce.

The reason Rule 11 Agreements are not more common is that most clients and professionals assume that real estate transactions cannot even occur for divorcing parties (before final divorce); but, mostly, it is because hardly any lending professional has created a path to such real estate transactions. Attorneys and realtors could, perhaps, create workable purchase agreements for cash transactions. But, most people need financing. And those lending standards become the key factor. This all began to change a few years ago when I introduced the idea of Rule 11 Agreements to mortgage underwriters.

 

Examples of Rule 11 Uses in Divorce-Financing Matters

1. A divorcing spouse wants to purchase a home, qualifying for the actual loan on his/her own but one or both parties do not want the other spouse to sign the Deed of Trust

Most lenders, realtors and title agents will tell you that this cannot be done for primary residences (homesteaded properties). They will nearly always default to “we require the signature of the spouse on the Deed of Trust if it’s a primary residence.” But, this is neither a legal nor mortgage finance requirement. In fact, married persons who are divorcing can purchase another primary residence before final divorce without their spouse’s signature on the Deed of Trust (and other ancillary documents normally required of “non-purchasing spouses”). Certain measures must be in place and such measures must be specified in a Rule 11 agreement. The actual mortgage terminology is “separation agreement.” But this is where confusion reigns. Since there is no legal status of separation in Texas, there is a premature assumption (on the part of most lenders, title agents and realtors) that no such agreement can be used in mortgage qualifying.

2. A divorcing spouse wishes to refinance a mortgage to meet the requirements of their negotiations but they need (or want) to close their mortgage transaction before final divorce. There could be several reasons for this requirement or desire. Some of them are

- a desire to close the loan while the borrower is able because qualifying in the future may not be possible.

- a desire to close the loan earlier than later because the borrower anticipates interest rates may rise.

- a need to “cash out” so that obligations might be satisfied (like payment to the soon-to-be ex-spouse. (We try to avoid such “cashing out” because the proper and superior method of paying a spouse for their interest in the property is to fund such buyouts via the Owelty agreement and lien; and, that can only happen after final divorce). Sometimes, though, the existing mortgage is a Texas Cash Out, the borrowers having formerly “cashed out.” This means that the existing mortgage can be financed (refinanced) only with another Texas Cash-Out mortgage (the “once-a-cash-out-always-a-cash-out rule).

- It’s better to close a loan when you can rather than to post-pone a loan closing until after (what could be) a long and drawn-out process.

 

3. Sometimes there is a need for a purchase transaction wherein one of the divorcing parties desires to help their spouse purchase a home, even becoming the borrower on such a loan. Most often this is one of those “amicable” divorces. It’s rare but we have had cases like such.

Any party in a petition of divorce, for a divorce not yet final, must (nearly) always have a Rule 11 Agreement in place if they require mortgage financing. The reasons were stated previously but are worth mentioning again here.

When two parties petition for divorce, this petition alerts the lender that several significant features in loan approvals are “up for grabs.” Naturally, a lender cannot discern income, assets and debts if those matters are in negotiation. A final decree of divorce will (almost always) specify all of those issues and enable the underwriter to determine precisely things like income, assets and debts amongst other important elements.  

For this reason and on occasion, we have advised couples (or individuals) to complete their mortgage financed transaction before filing a divorce petition. This avoids the need for a lender to require terms of settlement.

So, if I am the originating lender, do I have some responsibility (ethically, legally or contractually) to alert the underwriter that a divorce is imminent? ³ Well, in some cases, I might determine to put myself under that obligation. Otherwise, the answer is “no.” For one thing, even if an underwriter knew this, it would still not be documentable or verifiable information. Nothing has formally or legally been filed or petitioned. Also, there is always the option for reconciliation even after a divorce petition is filed. Consider that the only person that a divorced person can legally marry in the 30 days after their final divorce is their ex-spouse. Moreover, if any borrower is willing to put their own capital (down payment funds), credit and income at risk by signing a promissory note, that is the essence of lending and borrowing money. The one issue to which I must be sensitive is the “occupancy” status. I cannot allow a transaction to claim that the subject property will be “owner occupied” if, in fact, there is no intention to occupy that property as the primary residence of both borrowers. (There is sometimes an allowance for one of the borrowers not having to actually occupy). The actual statement is that the borrower intends to occupy the property as their primary residence within 60 days of purchase. There is no statement that a borrower must make that binds him/her to a particular length of stay.

 

Moreover, a Rule 11 may specify that a spouse will take no interest in their spouse’s purchase of a new property. (In this case, only certain lenders and certain title insurers will “sign off” on the transaction; it is possible that a spouse will not be required to sign the DOT as non-purchasing spouse). IN REFINANCE TRANSACTIONS of homestead properties, this is never the case. The spouse will always – we assume – be required to sign lien instruments, et al. as non-purchasing spouse.

 

Footnotes

² How would a lender know that a petition for divorce has been filed? A “title search” will reveal such a filing. Title searches for real estate transactions search, not only property matters but, personal matters as well. It’s called a “name search.” Such name searches will show bankruptcies, judgments (e.g., for back child support) and divorce petitions amongst other issues of public record.

³ Nowadays, the law and mortgage regulations are tending to hold the loan officer (originator) responsible (read “liable”) for virtually every possible piece of information in a loan applicant’s life. In the new ATR (Ability To Repay) guidelines (instituted by the all-powerful CFPB), loan officers and lenders are – and I know this sounds silly – supposed to know, in advance, how borrowers might use their discretionary income or what I call the 57%. Debt ratios will soon be limited to 43% but these new rules effectively hold the lender liable for how the borrower might – in the future – manage the remaining 57%. (I do not blame you if you do not believe me at this point; I am just telling you what the rules say as they are written).

Rule 11 Agreements - Part One

Rule 11 Agreements in Texas – Unexplored Territory

Part One

 

I am not sure how often Rule 11 Agreements are used in divorce proceedings in Texas; but, I have discovered a vast and untapped “market” for them – when divorcing parties require mortgage financing.

It may come as a surprise to attorneys that Rule 11 Agreement in Texas, like Owelty agreements, have a very important use that has largely been overlooked by lenders, real estate agents and legal professionals alike. In my business (of obtaining mortgage financing for divorcing parties), I am using them more and more.

For whatever other uses they have, Rule 11 Agreement are effectively “separation agreements” as far as mortgage underwriting is concerned. And that’s where the confusion comes in. Realtors and mortgage professionals have a cursory understanding of Texas law that governs marital status. Most think that there is no separation in Texas. You will see, in the first principle below, that this is a somewhat inaccurate statement as applies to mortgage underwriting and real estate transactions. At least, it leads non-attorney real estate professionals to inaccurate conclusions about the rules of their own industry.

Allow me to illustrate. I asked a group of realtors the following four questions:

1.      Can a person purchase a house while going through a divorce (i.e., before final divorce)?

2.      Can a potential buyer purchase a primary residence without their spouse’s signature on the Deed of Trust while going through a divorce (i.e., before final divorce)?

3.      Can a potential buyer get (qualify for) a mortgage while going through a divorce (i.e., before final divorce)?

4.      Can a potential buyer use child or spousal support as qualifying income to get a mortgage while going through a divorce (i.e., before final divorce)?

The answer to all four questions was overwhelmingly ¹“NO.”

The real answer to all four questions is, “YES.” And the document that makes it possible (all other qualifying factors assumed) is a Rule 11 agreement.

To be clear, no Fannie Mae, Freddie Mac, HUD or V.A. guidelines use the term “Rule 11.” It is obviously Texas-specific. But, what they describe is, in essence, a Rule 11 agreement.

Quoting from the Fannie guidelines (concerning the issue of how support income might be considered qualifying income) …

Verification of Income From Alimony or Child Support

Document that alimony or child support will continue to be paid for at least three years after the date of the mortgage application, as verified by one of the following:

• A copy of a divorce decree or separation agreement (if the divorce is not final) that indicates payment of alimony or child support and states the amount of the award and the period of time over which it will be received.

Note: If a borrower who is separated does not have a separation agreement that specifies alimony or child support payments, the lender should not consider any proposed or voluntary payments as income.

• Any other type of written legal agreement or court decree describing the payment terms for the alimony or child support.

 

The part that says “If a borrower who is separated does not have a separation agreement…” is the part that stalls mortgage professionals. They reason that since there is “no separation” in Texas, there can surely be no “separation agreement.” But, lending guidelines are insensitive to separation’s lack of legal status. They allow for such agreements. Notice that the guidelines then allow for “any other type of written legal agreement” in place of a formal “separation agreement.”

Texas lawyers immediately recognize this as a Rule 11. That’s how I discovered it. I recommended the use of an agreement typed out – as an underwriter instructed me – “on an attorney’s letterhead and signed by both attorneys.” One of my referring attorneys said, “Sure, that’s a Rule 11.” The only change we advise is that both parties sign the agreement as well.

So, under certain prescribed circumstances – as agreed by parties and specified in an executed Rule 11 Agreement – divorcing (but not yet finally divorced) parties can purchase homes, do so without their spouse’s signature at closing on the security instruments (e.g., Deed of Trust), and qualify with spousal and/or child support.


Footnotes

¹ Actually, a small minority of realtors were familiar with transactions wherein a divorcing (but not yet finally divorced) person had purchased residential real estate. But, they were clueless about any features that made such transactions possible.

Rule 11 Agreements like you never imagined them!

Did you know that mortgage underwriting allows for separation agreements even though there is no legal status of separation in Texas? Lenders see them as having nearly the same force as final decrees of divorce; at least for establishing factors in loan approvals. It's really quite amazing.

This means that, while most divorcing folks (along with nearly all real estate and mortgage professionals) think that they cannot qualify for mortgage financing before final divorce, with the proper agreements in place, they really can. They just need the right person who knows how to steer them through the intersection of divorce and mortgage finance.

It means that your divorcing clients can purchase homes before final divorce provided certain agreements are in place - no need to wait until final divorce.

It's also possible for support income - paid as good faith payments in anticipation of ordered support - can be used to qualify borrowers for mortgages. The key is a Rule 11 Agreement.

We've opened up an entirely new and unexplored world for divorcing clients. And I want you to know about it so that you can be the first to offer your clients that extra value and service you are known to offer.

 

Here's how you can be at the forefront of this untapped and unused knowledge:

First - watch for my articles in the next several days. They will give you clear principles about the use of Rule 11 Agreements as it relates to obtaining mortgage financing in divorce. The articles will appear on my blog about Divorce-Mortgage issues -http://divorce-mortgage.blogspot.com/

Second - Host this new CLE-Accredited presentation "Untapped Uses for Rule 11 Agreements."

It will be a one-hour course best presented over lunch in your conference room or at a Bar or Section meeting. I love speaking to collaborative practice groups as well. Call me at 817-454-4555 or email me at noel@themortgageinstitute.com.

I really love what I do - and these presentations are more than seminars and speeches - they are lab environments where we solve problems.

Call me or email me TODAY so we can get your CLE-accredited course scheduled.