Investment Cash-Out Loan versus Home Equity Loan
Below is a Texas refinance loan scenario on a residential property that creates a stalemate for the Lender, Title Company and Borrower.
Ted Mosby (“Borrower”) has owned and lived in his Texas home for 10 years. Borrower has received notice from his employer that he is being transferred to the Colorado office for work, permanently. Borrower moves to Colorado and decides to rent an apartment. Borrower does not sell his Texas home but decides to rent it out.
Borrower has been renting a Colorado apartment for almost a year and decides he wants to buy a home in Colorado. Borrower does not have cash for the down payment and he decides to refinance/cash-out on the Texas home in order to obtain money for the down payment on his soon-to-be primary home in Colorado.
Goliath National Bank (“Lender”) receives an application from the Borrower and it shows that the Texas home is an investment property and the Borrower currently rents an apartment in Colorado. Borrower does not own any other properties except the home in Texas. Lender underwrites the file as an investment refinance/cash-out and rate and term loan documents (“Normal Loan Documents”), are generated marking the Acknowledgment of Cash Advanced paragraph in Section 27 of the Deed of Trust.
On the day of closing, 123 Title Company, Inc. (“123 Title”) receives the loan documents from the Lender and 123 Title states they can’t close and insure the loan because the property is the homestead.
What is wrong with the Normal Loan Documents or the loan transaction? 123 Title believes the Texas home is the borrower’s homestead and if the Borrower want’s to cash-out on the property, then the loan must close as a Texas 50(a)(6) home equity loan with Texas home equity loan documents(“Texas Home Equity Documents”). The Lender cannot allow the loan to close as a Texas 50(a)(6) home equity loan because the property is not the Borrower’s primary residence and the Lender’s investor requires all Texas 50(a)(6) home equity loans to be the primary residence of the Borrower.
What is going on? (Legal versus Risk)
Under Texas law, property is not homestead unless the owner takes overt action to make it their homestead. Gregory v. Sunbelt Sav., F.S.B. 835 S.W.2d 155 (Tex.App.-Dallas 1992, writ denied). Overt action is generally moving into the property and using it as their place of residence and homestead. The use of the property and the intention of the owner is the paramount element of whether or not property is homestead. Once the homestead character of the property has been established by such overt actions, it does not cease to be the homestead until another homestead has been acquired or the owner has permanently abandoned the property as their homestead. Burkhardt v. Lieberman, 138 Tex. 409, 416, 159 S.W.2d 847, 852 (1942) [quoting Gouhenant v. Cockrell, 20 Tex. 96, 98 (1857)]. Thomas v. Graham Mortgage Corporation, 408 S.W.3d 581 (Tex.App.—Austin 2013, no pet.) Proof of abandonment requires clear and convincing evidence and in my opinion (and that of many Texas lawyers and title companies) the only fact which will arise to clear and convincing evidence of abandonment is that the owner moved out of the property and moved into and took up residence in another property which they own as their homestead. Merely occupying another residence does not constitute abandonment. Temporary renting of the homestead will not constitute abandonment of the homestead or change the homestead character of the property if another homestead has not been acquired. The homestead cannot be waived as long as the property remains the homestead. Texas homestead laws are liberally construed by the Texas courts so as to benefit those intended to be protected, the homestead owner. Therefore, the key issue is, has your Borrower ever lived in the home in Texas? In this situation, the Borrower has resided in the Texas home and therefore I don’t believe that any title company will believe that the Borrower has abandoned that homestead, by merely renting it out and living in rental property in another city. But, let’s also look at this homestead issue from a title company’s point of view. A title company insures that a lien is valid lien upon the subject property. If the homestead laws can defeat the lien, then the title company must pay the debt secured by the lien. Further, if an owner claims that the lien is not valid because the property was in fact their homestead, but homestead lending requirements were not met, the title company under the terms of their policy could spend enormous amounts of legal fees to defend against such a claim. Therefore, from a title company’s prospective, if there is any doubt, treat the property as being the owner’s homestead. In that manner, they cannot lose. Title companies are usually very conservative when the homestead issue is involved. So, regardless of whether or not the Borrower ever resided in the Texas home (or ever took sufficient overt action to make it his homestead), because he does not own and occupy other property as his homestead, a title company will usually take the position that “by default” the property is their homestead for title insurance purposes, because “it is the only residential property they own in Texas”.
What if the borrower never lived in the property?
Although title companies typically take the position that “by default” the property is their homestead for title insurance purposes, because “it is the only residential property they own in Texas” there is a slim chance, if you can provide evidence satisfactory to the title company that your Borrower has never resided in the Texas home, never took the legally required overt action to make it his homestead and he executes an affidavit that the Texas home is not his homestead, you may be able to get around the title company’s starting position, that the Texas home is your Borrower’s homestead by default. If the Borrower never occupied the property and has been renting the Texas home for more than 10 years, then a title company may consider the Texas home not homestead property. [See In re Cooper, 128 B.R. 632 (Bankr. E.D. Tex. 1991) holding that business rental property leased for ten years was not the debtor’s Texas business homestead.] My experience is that most title companies will simply not budge from their rule, that the property, for title insurance purposes, is by default the customer’s homestead.
How to recognize the issue during underwriting and processing:
If you receive a 1003 that shows the property as investment and the purpose of the loan is to refinance/cash-out or debt consolidation and the borrower currently rents an apartment, this is a red flag because of this possible issue. This becomes an issue of facts and whether or not the property is the homestead then determines what loan documents are necessary to close this transaction.
If you have any questions regarding this memorandum, please contact any of our firm attorneys or representatives below.
Allan Polunsky at Allan.Polunsky@mortgagelaw.com
Jay Beitel at Jay.Beitel@mortgagelaw.com
Marty Green at Marty.Green@mortgagelaw.com
Lauren Polunsky Dreszer at Lauren.Polunsky@mortgagelaw.com
Jonathan Jaskot at Jonathan.Jaskot@mortgagelaw.com
Andrew Duane at Andrew.Duane@mortgagelaw.com
Doug Foster1 at Doug.Foster@mortgagelaw.com
1Doug Foster is a non-lawyer and is not admitted to practice law in any state.