Rule 11 Agreements - #3: Sample Agreement with Notes

Thanks to all the attorneys who have helped refine and develop my materials on these Rule 11 Agreements. I never approached Rule 11 Agreements strictly from the legal perspective. Rather, they are a means to an end; specifically, they help us “get deals done” to put it plainly.

A Sample of a Rule 11 Agreement

Since I am not an attorney, I should be quick to preface that my customized, recommended Rule 11 Agreement a) is an outline of specific features of loan approval which the underwriting lender requires for loan approval, as pertains to a pending divorce and b) should be reviewed and edited by the attorney for proper “legal language.” We prefer that no other agreements be written into the particular Rule 11 Agreement that we are recommending other than what we specify? Why is this? Because we do not wish to confuse the underwriter with ancillary agreements that do not affect loan approval but which must be taken into consideration once the underwriter sees such agreements. Beyond factors like income, debt and assets, there are few other agreements that are necessary. But, each unnecessary feature of an agreement opens up the possibility that some additional “contingent liability” will be exposed. For example, at this moment underwriters do not count the multitude of children’s expenses (like medical expenses, health insurance, scouting, hobbies and sports and many others) against the supporting/paying parent’s debt ratios. However, this is most likely to change on January 1, 2014 when the CFPB’s enforcement of new (and still enigmatic) ⁴ Ability To Repay (ATR) rules go into effect. Even without these rules, given the current environment in lending, it’s only a matter of time until such stricter guidelines are applied.

In any case, one of our qualified Divorce-Lending Specialists will be able to specify exactly what needs to be included in the Rule 11 Agreement in order to make the mortgage loan approval work!

This sample contemplates that the wife, Jennifer, needs to purchase her own primary residence (the reasons are usually immaterial to the mortgage itself) but either Jennifer or her husband, John, does not want John to sign the Deed of Trust at closing (or any of the 5 or 6 other documents that non-purchasing spouses – really, non-borrowing spouses – are otherwise required to sign). (I do not wish to get bogged down here with explanations as to why lenders generally require spouses to sign Deeds of Trust and other documents at closing – I will cover this in a future article (and CLE-Accredited course) about real estate forms for family law attorneys).

This sample also assumes that Jennifer will have to rely on child and/or spousal support income to qualify for her loan and that she requires a certain amount of funds for down payment and reserves in order to qualify.

Comments and notes will be bracketed.

RULE 11 AGREEMENT

Pursuant to Divorce Cause No. 00-00000, Dallas County, Texas

RE: Purchase of 123 N. Main Street, Bogusville, TX, hereafter referred to as “property” or “the property.”

Parties: JOHN SMITH and JENNIFER SMITH

Agreement of Parties

 

1.      Divorce. The parties have filed petition for divorce;

2.      Property and Purchase.

a.       The parties agree that Jennifer may purchase the aforementioned property.

b.      There are no agreements in place that prohibit this transaction.

c.       John agrees to take no interest in the property and will execute a Special Warranty Deed to that effect upon final divorce. [There is no need to state that Jennifer is purchasing “on her own.” John’s agreement to “take no interest” addresses that concern as far as title or deeds. The fact that Jennifer alone is applying for the loan and the fact that John will not sign a promissory note is what causes Jennifer to obtain the property (and its attending mortgage) “on her own.”]

3.      Support Income/Payment.

a.       John will pay child support in the amount of $1,500/month.

b.      The children’s ages are 12 and 16 and support will continue until the standard time of emancipation.

c.       When the oldest child is emancipated, John will pay child support in the amount of $1,250 until the youngest child’s emancipation. [Such information is important because the oldest child’s support income is not considered qualifying because it will not continue for 3 years or longer. See “Credit and Mortgage Qualifying Issues in Divorce” for detailed information on qualifying income.]

d.      John will pay Spousal Support to Jennifer n the amount of $2,500/month for a period of no less than 3 years after final divorce or closing of Jennifer’s purchase of property.

e.       All informal payments of support are considered as support for the purposes of mortgage qualifying. No payments to date shall be considered as mitigating future support payments as agreed.

4.      Assets – [the idea is to clearly establish use of funds for “funds to close” and for reserves; these are two major factors in loan approvals. The Divorce-Lending Specialist will advise on the minimal need of such funds. Final division of assets does not necessarily need to be stated herein. However, the purchaser’s (Jennifer’s) full access to a minimal amount must be established.]

a.       Jennifer shall be awarded 100% of the following accounts and shall have full use of funds in these accounts for purchasing the property.

                                                               i.      Bank of America account no. 123456789

                                                             ii.      Fidelity Investments account no. 987654321

                                                           iii.      J. P. Morgan Chase Retirement account no. 192837465

b.      John shall be awarded 100% of the following accounts.

                                                               i.      Bank of Texas account no. XYZ

                                                             ii.      Edward Jones Investments account no. ABC

                                                           iii.      American Funds Retirement account no. MNOPQ-RSTUV

5.      Assignment of Debts – [the idea here is to establish the maximum amount of debts that will be assigned to the purchaser (Jennifer).]

a.       Jennifer shall be assigned the following debts

                                                               i.      CITI Card account no. 4239 XXXX XXXX 5390

                                                             ii.      FORD Motor Credit account no. XZ3098AG9999-063

                                                           iii.      JC Penny account no. 999111555

b.      John shall be assigned the following debts

                                                               i.      CapOne account no. 5398 XXXX XXXX 1277

                                                             ii.      TOYOTAL Motor Credit account no. AB2377XR99832

                                                           iii.      Discover account no. 6011 XXXX XXXX 8302

APPROVED

[It is my opinion that Rule 11 Agreements need to be signed by the parties and the attorneys filed with the clerk of court; initially, I had advised that since they are contracts such filing is superfluous and unnecessary. Indeed, Fannie Mae guidelines seemed indifferent to any such requirement for filing and state that the attorneys’ signatures are sufficient. This is probably because they are written to a national audience, leaving state-specific rules to be applied by the attorneys who prepare the documents for closing. However, I have come to know – thanks to one of my fine readers – that the Rule 11 Agreement is not enforceable as a contract unless it is signed by the parties and filed with the court.]

 

____________________________________________              ___________

JOHN SMITH                                                               DATE

_____________________________________________             ___________

S. SMART, ATTORNEY FOR JOHN SMITH           DATE

_____________________________________________             ___________

JENNIFER SMITH                                                       DATE

_____________________________________________             ___________

D. CRAFT, ATTORNEY FOR JENNIFER SMITH  DATE

 

From a legal perspective, you already know that many issues can be addressed in a Rule 11 Agreement. However, the preceding example addresses ONLY those issues that are pertinent to mortgage transaction. This is why I draft the initial agreement – I know what the underwriters (lenders and title insurance) need to see and what I do not want them to see. Any superfluous information superfluous to the mortgage / real estate transaction will only potentially “open and can of worms.” Moreover, guidelines and policies change. So, any template will be in constant need of revision. Just one more reason that you and your clients need a Divorce-Lending Specialist in many of your cases.

 

There is an important P.S. to the entire series on Rule 11 Agreements. It involves the requirement that a non-purchasing spouse (NPS) sign the Deed of Trust (and a few ancillary documents) at closing in a refinance transaction on a primary residence (homestead property). For now, let’s not dwell on the very real possibility that homesteaded properties can be partitioned during marriage and thus, separate property created without the need for a spouse to engage any enjoinder. The reality is that, it may be some time before lenders are willing to entertain such transactions.

Remember that attorney Kelly Bierig confirmed that in refinance transactions, the title company will require enjoinder of spouse and the signature of the NPS on the Deed of Trust. The problem with this exercise – and the reason for the P.S. – is that Deeds of Trust in Texas universally refer to the spouse (as well as the true borrower) as “borrowers.” Not pro forma. But, straight up (as the kids say) “borrowers.” Lenders will not change the wording on their documents to suit any nuance in a transaction. Perhaps the time will come when they will consider this. But, for now, no dice.

So, how do we understand and explain the strange reference to a non-purchasing spouse as a borrower in the Deed of Trust when no such borrowing/lending, in fact is taking place. Remember, the joining spouse is not signing the promissory note and has not even completed a loan application.

The Deed of Trust refers to all signatories as “borrowers” because the idea behind a Deed of Trust is that the grantors (homeowners) recognize that any claim they have to the property is subject to the promissory note (filed as a lien) against it. That is, a person with interest in the property cannot simply appeal to that interest as proof of ownership free and clear. If there is an unpaid balance on the mortgage, the lender’s interest is superior and must be satisfied. The Deed of Trust allows the lender to tell such a claimant, “that’s fine – you are vested on title to the house; now, all you have to do is abide by the terms of the loan if you wish to live in it.”

Thus, if a NPS never makes a claim to the property, they are never in the position of being a borrower with an obligation to repay the debt.

Call or write me with comments or questions.

Noel Cookman
noel@themortgageinstitute.com
817-454-4555

Pause . . . Some Questions & Answers About Rule 11 Agreements and Real Estate in Divorce

We interrupt this broadcast to bring you a special announcement...

 

Between the 2nd and 3rd installments of the series on Rule 11 Agreements, I thought it would be interesting to publish a few questions that came from attorneys on article #1 and the responses from a title attorney.

Special thanks to attorney Kelly Bierig, with Alliant National Title Insurance Company for his answers.

Question: I was always under the impression that the reason a mortgage company desired a spouses signature on a deed of trust, usually appropriately labeled as "pro forma," was to secure the deed of trust to be able to foreclose against the spouse who was not a party to the original sale deed and not a party to the mortgage note. In other words, one of the main purposes of the deed of trust is to get around homestead laws in Texas and be able to foreclose against both spouses either during the marriage or after dissolution.

Kelly Bierig: The purpose of a Deed of Trust security instrument is not to "get around" homestead laws. The Texas Constitution (Article 16, Section 50(a)) describes which types of loans are valid against a borrower's homestead. The Texas Family Code Section 5.001 also states that joinder of a spouse is necessary when the property is homestead.

With regard to purchases, Skelton v. Washington Mutual Bank is very clear that the purchase money will have priority over any homestead interest which could be claimed by the non-signing spouse.

There's even less risk when dealing with a borrower who is in the process of obtaining a divorce, since it's very likely that the divorce will be final prior to any foreclosure proceedings being initiated. I don't believe that there's any instance wherein I would refuse to insure a transaction because one spouse in the middle of a divorce was purchasing property, and the other spouse will not be joining on the security instrument. As long as there is no construction or cash back to the borrower, the risk is non-existent.

Question 2: Why would a mortgage company give up the protections of a deed of trust as to the rights of the non-purchasing spouse?

Kelly Bierig: I don't believe the mortgage company is giving up any rights. The security instrument has priority over any homestead interest the non-purchasing spouse could possibly claim, and there's an almost 100% certainty that the NPS (Non-Purchasing Spouse) will no longer be around by the time a foreclosure proceeding has been initiated. Most importantly, as long as the title insurer is willing to issue a Loan Policy which does not except to this issued, then the lender is covered under the policy if the foreclosure is challenged for this reason. The lender will never be in a position to suffer a loss.

Question 3: How does a Rule 11 Agreement enable the lender to enforce foreclosure if the non-signing spouse declares the property a homestead?

Kelly Bierig: Again, I still doubt this will ever be a problem, but the Rule 11 Agreement would act as an estoppel. In the above-referenced case, the borrower was not in the process of divorce. In order for this NPS to even claim an interest in the property, the divorce would have to be dismissed, and then the NPS would be subject to established case law and the Rule 11 Agreement.

On the other hand, if the proposed loan is a refinance or home equity, then they either need to wait until the divorce is final or require both spouses to join in the transaction.

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.