Removing Ex-Spouses From Mortgage Liability – Part III

The Deed of Trust to Secure Assumption – What it does and does not do....and how to solve a conundrum

Let’s understand once and for all what a Deed of Trust to Secure Assumption (DTSA) is and is NOT.

I got in trouble while giving my course on Owelties by saying, the DTSA, while always a good idea, is not a substitute for the grantee refinancing the property and does not really resolve anything. “Don’t listen to him,” the senior attorney was heard to say, “always require the DTSA.” She was correct. And since I wasn’t in disagreement on the matter, I suppose I was as well.

However, I have to make the point again – because clients do not just deal with legal and logical matters in their divorce, they deal with credit issues in perpetuity. And a DTSA does not protect credit. Its intent may be to protect the credit of the grantor, but it does no such a thing. In fact, the DTSA can only be triggered if and when the grantee’s credit has already been damaged! Think about it. Unless the grantee of a DTSA has significant enough resources at any given point in time, the DTSA may not even protect the collateral interest it alleges to protect.

The DTSA gives its grantee (usually the same person as the grantor of the Special Warranty Deed) a mechanism whereby he/she can be spared TOTAL ruination (spell check wanted to change that to “urination”) of credit. But, there is no automatic protection of credit. In fact – and it is worthy of repetition - the single and only event that triggers the DTSA is a default on credit. So, before the grantee takes a single action to foreclose on their DTSA, a late payment has been recorded on his/her credit. One may think this a small thing but, in reality, it most often disqualifies a borrower from obtaining a mortgage for at least 6 months and easily up to 12 months.

It gets worse. I used to tell my customers that a DTSA meant that if their ex-spouse was late on a payment, the grantor (of the Special Warranty Deed; grantee of the DTSA) could knock on the front door, kick their ex-spouse to the curb and take possession of the house. You and I both know that it’s not that simple.

Here’s what happens. There is a foreclosure process that must be followed. This process could easily take months; and, unsophisticated citizens are completely unaware of that process which means days, weeks, months can pass before the required paper work is filed and action is taken. Meanwhile, during these intervening weeks/months, even more late payments will “hit” the grantor’s credit report. If the mortgage becomes “4 months down,” the grantor will be assumed to have had a foreclosure on their credit report, whether or not the lender actually forecloses.

Moreover, the DTSA’s grantee may not even be aware that his credit is damaged until months have passed. The notices for late payments are sent to the property address.

At this point, the client (who thought his interest and credit was “protected”) cannot obtain conventional financing for at least 4 year or FHA financing for 3….and that’s only if their credit scores recover in the intervening years. As I pointed out above, at the least, one late mortgage payment on an applicant’s credit report will delay a home purchase/refinance for 12 months or, at least, 6 months (in some FHA loans so long as there has been no other late payments in the preceding 6 months).

Sure the Deed of Trust to Secure Assumption protects a grantee’s interest by giving them the right to retake the collateral. But, if your client is the grantee of a DTSA, that document puts your client in the foreclosure business. There is a common misconception that banks enjoy foreclosing on properties they have financed or that they actually want to foreclose. This is wholly untrue. Banks and lenders outsource the foreclosure process because it’s complicated, expensive but mostly because foreclosing is not the business they want to conduct. The first thing they do is sell it at auction at a fire sale price. The few properties that have a “ton of equity” do not make up for the many for which they take a loss. Ask yourself how many of your clients actually want to be in the foreclosure business . . . on properties for which they have advanced their own money.

The DTSA creates a “contingent liability.” In many ways, a contingent liability is worse than a standard liability because you never know if and when you will have to service the debt. Imagine if you have to manage your finances that way – “My monthly expenses are $2,000 per month but they might be $3,500….don’t really know.”

Here’s another way to understand what the DTSA does. It provides an opportunity which, when combined with a sizeable amount of money and ongoing expense (house payments, probably the largest monthly expense in most folks’ budget), can begin to remedy a dire situation created by another party (one’s ex-spouse). People get divorced for a reason….and, it’s usually not because they want to pay for their ex-spouse’s living expenses beyond ordered support.

Here’s the rub from my view: As negotiators sit around the table and discuss these issues, as one attorney told me, the grantor (of the DTSA) will often offer the DTSA as a way to equalize the fact that they allegedly cannot finance the property in their own name. It’s treated as tit for tat. Hopefully, we all see that being granted the DTSA doesn’t put a thing in the plus column for the grantee.

Right about now, you are probably thinking “Good grief, Cookman. We know all this. We need to know how to solve the problem, not just understand it more clearly.” And, here is the simplest, most straightforward, fair solution:

Always (with so few exceptions that we could still say “always”) require the party awarded a financed property to (re)finance that debt out of the grantor’s liability. I say it this way because, many times, the option is for a friend or relative of the awarded party to perform the financing but the key feature is that the grantor is effectively relieved of the debt. And, set a time limit on it - I can advise how long for each individual case; and, it will rarely ever be more than 24 months – with the provision for the property’s sale if financing has not transpired. This means that you will probably never again have to use the phrase “[party] will make every good faith effort to refinance the mortgage….”

The only way to properly and effectively do this is for the awarded party to call me….and call me sooner than later…..as in, before final divorce and very soon after filing petition if at all possible. Most lenders will tell your clients, “get your divorce finalized, bring us the decree and let’s see what we can do.” This is devastating to a majority of cases and transactions. And there is no good reason why lenders should wait until terms are chiseled in stone. I don’t wait. But, the fact is, most of them are not sure what to do during the process. On the other hand, I make sure that you get approvals (with specific conditions and an outline of the structure for your decrees) before final divorce. That way, there are no questions and there is no wondering what will happen to the debt.

Boom yow! You and I just saved the world….or at least an important part of it for a whole lot of people.