Lease Purchase Options: Do or Don’t and the Alternative By: T. Alan Ceshker The Law Offices of T. Alan Ceshker T. Alan Ceshker Attorney with the Law Offices of T. Alan Ceshker JD 1991 – University of Texas School of Law Specialize in Real Estate and Construction Law. Assists Investors with Creative Financing Alternatives. Handles both the drafting of real estate documents and litigation regarding real estate transactions. 22 years of un-screwing people. Owner: Independence Title Company – Ceshker Group Disclaimer This presentation has been prepared by the Law Offices of T. Alan Ceshker for informational purposes only and is not legal advice, does not necessarily reflect the opinions of The Law Offices of T. Alan Ceshker or any of its attorneys or clients, and is not guaranteed to be correct, complete, or up-to-date. This presentation is not intended to create, and access to or receipt of information included in this presentation does not constitute, a lawyer/client relationship. No one should act upon this information without seeking professional counsel. This presentation was created by the Law Offices of T. Alan Ceshker and, except as otherwise indicated, is © 2007-2013 by the Law Offices of T. Alan Ceshker. All rights are reserved. Translation: I am not your lawyer at this time. This stuff could be wrong. More accurately, the laws may have changed after this presentation. Always hire legal counsel regarding any investor related questions. Don’t steal my stuff. Lease Purchase Options: Overview In 2005 the Legislature decided to protect consumers from the unscrupulous individuals who were taking advantage of aspiring home owners via lease purchase option agreements. Sellers were taking great advantage of low end buyers. Now – the law provides for immense protection of buyers. Lease Purchase Options: The Law Chapter 5, Subchapter D Sec. 5.061 et seq. of the Texas Property Code governs lease purchase options. Definition of Lease purchase option: An option to purchase real property that includes or is combined or executed concurrently with a residential lease agreement, together with the lease, is considered an executory contract for conveyance of real property and subject to the rules of this subchapter §5.062(a)(2). Translation: A lease agreement and a purchase option regarding the same property signed at the same time is now regulated by the statute. This includes a contract for deed. Applicability This Chapter applies to all properties that are to be used as the purchaser’s residence. By definition, a lot measuring one acre or less is presumed to be residential property. Major Exceptions: The statute does not apply to commercial transactions The statute does not apply to an executory contract that provides for the delivery of a deed from the seller to the purchaser within 180 days of the date of the final execution of the executory contract §5.062(c). Translation You can do a lease purchase option for 179 days or less and not have to comply with §5.061 et seq. No – a month to month or renewing agreement will not work. No – a verbal agreement will not work. No – your revolutionary idea does not work. Some of the Pitfalls Seller must provide a survey which is no older than a year; Seller must provide copies of liens, restrictive covenants, and easements affecting the property; Buyer may cancel the contract for any reason within 14 days of signing; Excessive late fees are banned; Seller must provide an annual accounting statement; Buyer has a 30 day unconditional right to cure any default; If a seller is liable to a purchaser under this subchapter, the purchaser, without taking judicial action, may deduct the amount owed to the purchaser by the seller from any amounts owed to the seller by the purchaser under the terms of an executory contract; and Any violation is a Deceptive Trade and Practices Act violation A violation entitles the purchaser to cancel and rescind the executory contract and receive a full refund of all payments made to the seller. More Problems The purchaser can obtain title by delivering a promissory note that is equal in amount to the balance of the total amount owed by the purchaser to the seller. The seller must then convey the property to the purchaser. “The” Problem A seller may not, under any circumstances, enter into a lease purchase option agreement with a purchaser if the seller does not own the property free and clear §5.085(a). The Exception - Not This subsection does not apply to a lien or encumbrance placed on the property that does not prohibit the property from being encumbered by an executory contract – i.e. a loan that does not have a due on sale clause. The Clincher If you violate the statute, the purchaser may cancel and rescind the executory contract and receive from the seller: the return of all payments of any kind made to the seller under the contract; and reimbursement for: any payments the purchaser made to a taxing authority for the property; and the value of any improvements made to the property by the purchaser. The Bottom Line Lease purchase options are allowed but NOT a viable option The Solution: Mortgage Wraps Definition: The seller financing of a property that does not pay off the current mortgage lien on the property. The property is conveyed and the existing mortgage lien stays in place with a second, junior lien held by the seller. Two Types of Seller Finance Transactions Underlying Loan No Underlying Loan Mortgage Wrap Subject to Assumption Used in Assignment transactions Terminology Subject to: Used when the buyer is purchasing and the seller is no longer involved and has no equity interest in the property. I.e. the seller is not owed funds under a promissory note. Assumption: the buyer is assuming the underlying loan with the permission of the lender. Mortgage Wrap: the seller is carrying a promissory note in which the payment is above the underlying loan payment. Also commonly used to refer to all seller finance transactions with underlying liens remaining. Preliminary Concerns Regarding Wraps SAFE Act T-SAFE Act Dodd-Frank Act These Acts prohibit a lender/seller from taking applications and negotiating terms of a new note unless they are a licensed residential mortgage loan originator. If not licensed, the lender-seller must utilize the services of individuals who are licensed or an attorney. De Minimus Exceptions SAFE Act and T-SAFE Act An individual who engages in no more than 5 mortgage loans in a rolling 12 month period is exempt. Dodd-Frank Act Property owners who offer seller financing for 3 properties or less in a rolling 12 month period are exempt from being licensed as a loan officer. The Exemption to the De Minimus Exception of the Dodd Frank Act Must still comply with: 1. The seller did not construct the home to which the financing is being applied; 2. The loan is fully amortizing (no balloon mortgages allowed); 3. The seller determines in good faith and documents that the buyer has a reasonable ability to repay the loan; 4. The loan has a fixed rate or is adjustable only after 5 or more years, subject to reasonable annual and lifetime caps. Due on Sale Clause This is a non-issue The most talked about topic of a mortgage wrap. The most infrequently occurring issue in real life transactions. See me after if you wish to enter into law school geek discussions about hypotheticals. How to do a Mortgage Wrap Use the TREC 1 to 4 contract and choose Seller Financing in Paragraph 4 C. Use the Seller Finance Addendum for Mortgage Wraps (Form 26-6). Use the Loan Assumption Addendum for Subject to transactions (Form 41-2). Use a wrap around addendum for special circumstances. Receipt the contract with a attorney/title office. Purchase title insurance. The rest runs like a normal transaction – sort of. Major Concern: Home Owner’s Insurance The buyer must purchase new insurance. The seller need not maintain insurance. The seller must be listed as an “additional interest”. The lender must be listed in the “mortgagee’s clause”. The insurance agent must be familiar with mortgage wrap insurance. Failure to get the insurance in place is the most common reason for a mortgage wrap to fail. Loan Servicing Use a loan servicing company familiar with mortgage wraps. Often if the buyer is an investor and re-selling via a mortgage wrap, the seller and end buyer do not require a loan servicer. 5.016 Notice Texas Property Code requires a notice be provided to the buyer of a property if encumbered by a recorded lien. Provides information about the loan, taxes, insurance Not needed if you purchase title insurance. Provide the notice regardless. Closing Documents Required If you have a Mortgage Wrap, need the full set – i.e. DOT, Promissory Note, Warranty Deed with Vendor’s Lien, Disclosures. If you have a Subject to, a full set is not required. Use a full set regardless. You do not want to appear later that you took advantage of a seller or buyer. Costs You can get some forms from an attorney out of Waco for $150.00 and do it yourself. You can go to a title company and they get some forms from their in-house attorney or their go-to attorney for $300 to $750. Please take my business card if choosing this option for future litigation representation. Probably safe on 3 out of 10 wrap transactions. Use a fee title office with an active attorney specializing in mortgage wraps. The cost ranges from $750 to $4,000 plus. The End of a Mortgage Wrap The Buyer will either sell the property or refinance and payoff the underlying loan. I advise parties to try and keep the term of the wrap as short as possible – i.e. 2 to 5 years. Questions?