Texas Homestead Protections
Can You Make a Business Purpose Loan on a Primary Residence in Texas?
Texas homestead protections are unique for homeowners seeking to obtain home loans. Its “homestead” protections are embedded in its Constitution and are among the most restrictive in the U.S. In this article, we will explore those restrictions and provide tips on safely making residential loans in Texas.
The Texas Constitution prohibits the forced sale of homestead property for the payment of all debts unless the debt is one of eight types. Texas courts strictly enforce these constitutional protections, “even though in so doing the court might unwittingly assist a dishonest debtor in wrongfully defeating his creditor.” PaineWebber, Inc. v. Murray, 260 B.R. 815, 822 (E.D. Tex. 2001).
Before making a loan, lenders must first assess whether the property and transaction comply with Texas homestead laws. The following inquiries provide the legal interpretations needed to determine whether the property is protected as a homestead and whether the loan can be properly secured.
Inquiry 1: Is the subject property the borrower’s homestead?
The “[p]ossession and use of land by one who owns it and who resides upon it makes it homestead in law and in fact.” NCNB Tex. Nat’l Bank v. Carpenter, 849 S.W.2d 875, 880 (Tex.App.-Fort Worth 1993, no writ). However, the situation is often not so clear cut, and a deeper analysis may be necessary.
To create a homestead in Texas, there must be both (a) ownership and (b) occupancy or intent to occupy. Typically, homestead property is owned in fee simple, but a claim may be based on a life estate, leasehold, or beneficial interest in a trust. The ownership element must be based on an interest in real property— so a houseboat does not qualify, but a manufactured home that’s permanently attached to land could qualify. Even vacant land can qualify if the owner plans to live on it within a reasonable time frame and has made some preparations toward actual occupancy.
Homestead protections are meant for families or single adults, not companies. Accordingly, a residential property is not a homestead if title is held by a business entity, even if the business entity’s owner resides on the property. (Refer to Inquiry 3 for a lender tip on this topic.)
There is no maximum dollar limit for homestead property, but there are size limits based on acreage. An urban homestead is limited to 10 contiguous acres, while a rural homestead may be non-contiguous and shall not exceed 100 acres for a single adult or 200 acres for a family. Section 41.002 of the Texas Property Code provides a test to determine whether a property is legally urban or rural.
Finally, it’s important to distinguish between two similarly named but legally distinct concepts: the residential homestead tax exemption and the homestead protection. The homestead protection (which is the subject of this article) arises automatically by operation of law to protect the owner’s homestead from forced sale. Distinguish this from the homestead tax exemption under Section 11.13 of the Texas Tax Code, which allows homeowners to elect to exempt part of their home’s taxable value to lower their property taxes. The presence of a homestead tax exemption is strong evidence that the property is the owner’s homestead. However, because the exemption is elective, the absence of the exemption does not conclusively prove that a property is not the owner’s homestead.
Inquiry 2: What lien types may be secured by homestead property?
Article 16, Section 50(a) of the Texas Constitution states: The homestead of a family or single adult is protected from forced sale for the payment of all debts, except for:
(1) | the purchase money thereof, or a part of such purchase money; |
(2) | the taxes due thereon; |
(3) | an owelty of partition imposed against the entirety of the property by a court order or by a written agreement of the parties to the partition, including a debt of one spouse in favor of the other spouse resulting from a division or an award of a family homestead in a divorce proceeding; |
(4) | the refinance of a lien against a homestead, including a federal tax lien resulting from the tax debt of both spouses, if the homestead is a family homestead, or from the tax debt of the owner; |
(5) | work and material used in constructing new improvements thereon, if contracted for in writing, or work and material used to repair or renovate existing improvements thereon…; |
(6) | an extension of credit that [is a compliant home equity lien]; |
(7) | a reverse mortgage; or |
(8) | the conversion and refinance of a personal property lien secured by a manufactured home to a lien on real property, including the refinance of the purchase price of the manufactured home, the cost of installing the manufactured home on the real property, and the refinance of the purchase price of the real property. |
Section 50(c) goes on to state, “[n]o mortgage, trust deed, or other lien on the homestead shall ever be valid unless it secures a debt described by this section…” Stated another way, any loan secured by homestead property in Texas must be one of encumbrances listed above, or the loan will result in an invalid lien. Notice that this list does not include an exception for business purpose loans.
In Texas, any forward, cash-out mortgage loan secured by the borrower’s homestead must be written as a fully amortized, fully compliant consumer home equity loan under Section 50(a)6. If written as a business purpose loan, it would result in a constitutionally noncompliant, unenforceable home equity lien.
The unenforceable nature of such an invalid home equity loan is not something that will go away with time. The Supreme Court of Texas made it clear “that liens securing constitutionally noncompliant home-equity loans are invalid until cured and thus not subject to any statute of limitations.” Wood v. HSBC Bank USA, N.A., 505 S.W.3d 542 (Tex. 2016).
Bottom Line
Lenders making business purpose loans secured by residential property in Texas must be certain the property is NOT the borrower’s homestead.
Inquiry #3: Lender Compliance Tips
Non-homestead affidavits. Prudent lenders who make loans secured by non-homestead residential property in Texas require the borrower to execute a non-homestead affidavit. This is a sworn statement in which the borrowers and owners disclaim homestead rights in the collateral and claim them for another property they own in Texas. Article 16, Section 50(d) of the Texas Constitution states “[a] purchaser or lender for value without actual knowledge may conclusively rely on an affidavit that designates other property as the homestead of the affiant and that states that the property to be conveyed or encumbered is not the homestead of the affiant.” However, it is important to understand that homestead protections cannot be waived and are not easily lost. “Once property has been dedicated as homestead, it can only lose such designation by abandonment, alienation, or death. After the party has established the homestead character of the property, the burden shifts to the creditor . . . to disprove the continued existence of the homestead. In other words, a homestead is presumed to exist until its termination is proved.” Wilcox v. Marriott, 103 S.W.3d 469, 472 (Tex.App.—El Paso 2005, pet. denied). This means that if a property is actually the borrower’s homestead, the mere signing of a non-homestead affidavit does not waive homestead protections, and the lender cannot rely on the affidavit if it knows the property is the borrower’s homestead.
Conversion of homestead property to non-homestead property. As stated above, homestead protections are only lost through sufficient abandonment, alienation, or death. The gold standard for converting homestead property to non-homestead property is for the owner to move out with the intent to abandon it as their homestead, move into another Texas property they own, and start using that property as their homestead.
Co-owners. Lenders should be wary of co-owners who may have a homestead interest in the collateral. If the property is the homestead of at least one co-owner, even if that co-owner is a non-borrower, the property is considered homestead property. In such a case, a business purpose loan should not be made unless and until all homestead interests are sufficiently abandoned or alienated by all co-owners.
Pretended sales. We have been asked whether it is legal to make a business purpose loan secured by a borrower’s homestead if the borrower first conveys the property to a business entity, such as an LLC. This is an apparent attempt to defeat homestead protections by transferring record title to a business entity. This is a risky business practice, and we do not advise it. Under Texas law, there is potential for the borrower to successfully have the conveyance set aside by a court as a pretended sale. Article 16, Section 50(c) of the Texas Constitution states “[a]ll pretended sales of the homestead involving any condition of defeasance shall be void.” As an example, if a borrower deeds their homestead to their LLC but includes a condition of defeasance, such as an option to repurchase in the deed or a lease, a court may declare the conveyance void. The effect would be that the property was not conveyed to the LLC and remains the borrower’s homestead. A cash-out business purpose loan made against such a property would result in a constitutionally invalid and unenforceable home equity lien.
The Price of Noncompliance with Texas Homestead Laws
Homestead laws can make mortgage lending in Texas complicated. The laws in this area are nuanced and the consequences for noncompliance are steep, including lien invalidation and loss of principal and interest. That is why it is imperative that lenders understand the law or have experienced attorneys on their side.
Doss Law, LLP has assisted lenders for decades. If you have any questions about these or other legal matters, feel free to reach out by phone or email.