The Texas legislature is at it again. Just a couple of years after severely restricting the ability of real estate investors to sell residential property on a lease option or contract for deed, our representatives have passed a law requiring a massive disclosure whenever a seller conveys a house without paying off the underlying mortgage(s). NOTE: this disclosure is not required if the buyer gets a title insurance policy, so if you always insist on title insurance when you sell a property, you won’t have to worry about this.
Texas Property Code § 5.016, which became effective on January 1, 2008, applies whenever a seller sells, or contracts to sell, an interest in residential real property “that will be encumbered by a recorded lien at the time the interest is conveyed.” That means the statute applies any time a residential property is sold without paying off the existing mortgage or other liens. So if you are selling a house “subject to” the existing mortgage, or selling on a wraparound mortgage, or – theoretically – even conveying a property to the dreaded Ron Legrand “land trust,” you will have to comply with this new law.
You know, technically speaking, a lease is an interest in land, so you could argue this law even applies to residential leases! But I’m sure that’s not what the legislature intended, and I can’t see anyone successfully arguing that this statute should apply to landlords. So let’s just worry about sellers.
If your residential sales contract falls under the statute, then you must give the buyer and each lienholder a separate written disclosure statement in at least 12-point type that:
(1) identifies the property and includes the name, address, and phone number of each lienholder;
(2) states the amount of the debt that is secured by each lien;
(3) specifies the terms of any contract or law under which the debt that is secured by the lien was incurred, including, as applicable:
(A) the rate of interest;
(B) the periodic installments required to be paid; and
(C) the account number;
(4) indicates whether the lienholder has consented to the transfer of the property to the purchaser;
(5) specifies the details of any insurance policy relating to the property, including:
(A) the name of the insurer and insured;
(B) the amount for which the property is insured; and
(C) the property that is insured;
(6) states the amount of any property taxes that are due on the property; and
(7) includes a statement at the top of the disclosure in a form substantially similar to the following:
WARNING: ONE OR MORE RECORDED LIENS HAVE BEEN FILED THAT MAKE A CLAIM AGAINST THIS PROPERTY AS LISTED BELOW. IF A LIEN IS NOT RELEASED AND THE PROPERTY IS CONVEYED WITHOUT THE CONSENT OF THE LIENHOLDER, IT IS POSSIBLE THE LIENHOLDER COULD DEMAND FULL PAYMENT OF THE OUTSTANDING BALANCE OF THE LIEN IMMEDIATELY. YOU MAY WISH TO CONTACT EACH LIENHOLDER FOR FURTHER INFORMATION AND DISCUSS THIS MATTER WITH AN ATTORNEY.
Yikes! That’s a hefty disclosure. Not only that, but the disclosure must be delivered at least 7 days before the effective date of the sale or the effective date of the contract, whichever is earlier. Whoa – did I say before the effective date of the contract? Yes indeed, that’s what the statute says, even if it may not be what the legislature meant. This certainly throws a wrench in the plans of investors who want to sell their properties within 7 days.
So what should an investor do to comply with the statute? Well, the easiest solution is to insist on title insurance for the buyer, which is an exception to the disclosure requirement. Of course, that adds cost and complexity to the transaction. If that’s not an option, then the best thing to do is probably to deliver the disclosure – to the buyer and lienholder – with the executed contract, but make the “effective date” of the contract 7 days later. You can still close at any time after that, even on the effective date of the contract, if need be. But remember that the statute also says that if the buyer does not receive the notice with the contract, he can cancel the contract for any reason up to seven days after receiving the notice.
Selling with seller financing or on a wraparound mortgage is still an excellent way for Texas real estate investors to maximize their profits and minimize management headaches, and I recommend it to many of my clients. But take care that you’re doing it right, either with title insurance or all the proper disclosures.