Texas has strong protections from the forced sale of homestead property; however, there are some limited exceptions for certain types of liens that do attach to homesteads. It is well settled that non purchase money loans from hard money lenders will not attach to homestead properties in Texas.
If unable to qualify for a home equity loan, many homeowners are forced to turn to hard money lenders as a source of funding. In turn, hard money lenders desirous of earning high interest rates have been forced to invent creative ways to circumvent Texas’ strong homestead protections. One such method employed by lenders is to require the homeowner to create an LLC owned by the homeowner and deed the homestead into the LLC. As homestead protection is only afforded to individuals in Texas, lenders have dangerously assumed that the borrower would then be unable to avail himself protection from forced sale of the property.
Lenders should be aware that borrowers in the above situation may be able to successfully argue that the transfer of the homestead into an LLC owned by the borrower was nothing more than a pretend sale and such transfer is void. The Texas Constitution declares void a pretended sale involving any condition of defeasance. Tex. Const. Art. XVI, § 50(c). To prove a pretended sale involving a condition of defeasance prohibited by the Texas Constitution, there must be evidence that: (1) the seller did not intend title to vest in the purchaser; and (2) the transfer involves a condition allowing the seller to reclaim title to the property after the loan is repaid. See Hardie & Co., 63 Tex. at 295.
To be clear, a borrower that intentionally deeds his homestead into an LLC for the purpose of procuring a hard money loan does not automatically get to claim the sale was a sham. There must be something more. Courts will weigh all factors in determining whether the conditions of a pretend sale are met. For example, a court may consider all evidence such as an option for the borrower to by the property back (See Tittle v. Vanleer, 89 Tex. 174, 34 S.W. 715, 722 (1896).), continuous occupation of the property, execution of a deed for no consideration, and the grantee being a newly formed entity wholly owned by the borrower. See In re Whitcomb, 599 B.R. 908, 916 (Bankr. S.D. Tex. 2019).
It is clear from recent cases that hard money lenders making loans associated with homestead property is a risky business, and borrowers that transfer properties into entities may have more leverage than originally anticipated. The analysis regarding pretended sales in Texas is a complex one, and a competent real estate lawyer should be hired if you are anticipating litigating these types of transactions.
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