Rule 11 Agreements in Texas – Unexplored Territory
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 requiresa 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.
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).