Financing Real Property

Question 1

Financing Real Property Basics

Answer 1

● To purchase property, borrowers borrow money from:
○ Financial institutions (banks; mortgage lenders)\
○ Sometimes sellers
● Borrower usually completes two documents:
○ Promissory note (or “mortgage note”) (Contract)
○ Mortgage or deed of trust on property: “secures” the debt – gives lender (mortgagee) the right to sell and obtain proceeds if the borrower (mortgagor) doesn’t pay back the debt
■ The property constitutes the “security” or “collateral” for the loan

Question 2

Promissory Note

Answer 2

● Personal contract establishing personal liability for loan
● Indicates loan amount
● Sets interest rate (fixed or adjustable)
● Sets timeline (e.g., 30 years)
● Sometimes: prepayment clause (permitted if mortgage allows, often with penalty)
● Often: “acceleration” clause: If mortgagor defaults, owes entire amount
● Often: “due on sale” clause: If mortgagor sells property, Lender has the right to demand the loan balance

Question 3

Requirements for Mortgages

Answer 3

● Statute of frauds: Must be in writing and signed by the party to be bound (borrower)
● Must include a description of the property
● Recordable interest
○ Recorded mortgage means security interest will bind subsequent purchasers
○ Complying w/ recording statute protects mortgagee (lender) from prior unrecorded interests

Question 4

Title and Lien Theories of Mortgages

Answer 4

Lien theory: Lender obtains a “lien” on the property
● Lien: the right to sell (to foreclose on) the property if the borrower fails to repay

Title theory: Lender obtains title to the property until borrower pays off debt
Significance:
● For most purposes, borrower treated as owner
● Joint tenancy: Mortgage of separate interest could sever (in theory)

Question 5

Judicial Foreclosure

Answer 5

Foreclosure: If borrower defaults (fails to pay loan payment), the lender can foreclose (have property sold and recoup unpaid balance from sale proceeds)

In a traditional judicial foreclosure, lender must bring suit and court oversees foreclosure sale and distribution of proceeds

Question 6

Mortgage with Power of Sale

Answer 6

Mortgage with Power of Sale: Mortgage authorizes the lender to sell the property at auction and distribute the proceeds

Question 7

Deed of Trust

Answer 7

● Functionally equivalent to mortgage with power of sale
● Borrower is “trustor”
● Equivalent to mortgagor
● Borrower grants property interest to “trustee” (often bank official), not lender
● If borrower defaults, lender tells trustee to foreclose
● Lender is the trust’s beneficiary
○ Equivalent to mortgagee

Question 8

Mortgagor’s (Original Borrower) duties

Answer 8

● Mortgagor (or Trustor) obligations designed to protect property’s value
● Mortgagor risks foreclosure if fails to abide by obligations

Examples of Duties Listed in Mortgage:
- Make government payments (taxes/assessments)
- Maintain property insurance
- Defend title to property (e.g., against adverse possession claims)

Question 9

Transfer by the Mortgagor (Original Borrower)

Answer 9

Default rule : Mortgages are property interests that attach to and run w/ the land to the grantee

Anything that might protect the new buyer from the mortgage?
- Recording statute, if buyer meets the terms

Default rule: If deed is silent, Buyer is not personally liable but still faces risk of foreclosure (unless protected by the recording statute)

If agreement between Seller and Buyer provides the Buyer is:
● Assuming the loan: If Buyer “assumes” the loan, Buyer becomes personally liable and faces risk of foreclosure
● Subject to the loan: If deed Buyer takes the property “subject to” the mortgage, Buyer is not personally liable but still faces risk of foreclosure

Surety: Original mortgagor remains personally liable for the loan based on the original promissory note (a surety),unless they are released from the obligation by the mortgagee (e.g., bank).

Question 10

Borrower’s Pre-Foreclosure Rights

Answer 10

Stage 1: Borrower in default (before lender “accelerates” the loan)
- “Reinstate” loan: borrower makes all late payments
- Post mortgage crisis: Some states require lenders to offer loan modification options

Stage 2: Lender “accelerates” loan
- Borrower: “Equity of redemption:” right to “redeem” by paying full amount due

Question 11

Deed in Lieu of Foreclosure

Answer 11

Deed in lieu of foreclosure
- If Borrower and Lender agree, borrower gives lender the deed
- Uncommon because bank takes subject to all liens/interests on the property

Question 12

Judicial Foreclosure Process: Lawsuit Phase

Answer 12

Complaint: Lender files complaint against “necessary” parties:
- Borrower
- Junior lienholders
- All other junior interests (e.g. junior servitude holders)

Answer: Borrower and other defendants can answer.
● Possible claims:
○ No mortgage in the first place
○ No default: payments are up-to-date
○ Defense (personal or real) to mortgage formation

Question 13

Judicial Foreclosure Process: Sale Process

Answer 13

1. Authorization: Judge authorizes foreclosure sale
2. Notice: Lender provides notice of public sale
3. Public Auction

Question 14

Non-Judicial “Power of Sale” Foreclosure

Answer 14

● Mortgage document must provide for “power of sale”
● Most states: impose statutory requirements, like:
○ Advance notice of intent to foreclose to borrower
○ Notice to all junior interest holders
○ Public notice of sale
● Public sale conducted by lender or by trustee (if deed of trust)
● No direct judicial role

Question 15

Foreclosure: Key Questions

Answer 15

1. Interests: What happens to interests in the land (e.g., mortgages, judicial liens, easements)?
2. Distribution: How should the proceeds of the sale be distributed?
3. Deficiency: Who can the lender pursue for deficiency if the proceeds are not sufficient to cover the debt?

Question 16

Foreclosure: Interests

Answer 16

● Post foreclosure, the senior interests are still attached to the property (e.g., senior lien and easement).
● Post foreclosure, the junior interests are eliminated (e.g., junior lien and lease)
● Post foreclosure, the foreclosing lender’s lien is eliminated.

Question 17

Foreclosure: Distribution

Answer 17

How should the proceeds of the sale be distributed?

Assuming no special priority-changing rules, what rules determine the order in which the proceeds are distributed?
1. Foreclosing lienholder
2. Junior lienholders
3. Borrower

Senior lienholders do not get anything, but their liens remain on the property

Question 18

Foreclosure: Deficiency

Answer 18

Who can the lender pursue for deficiency?

If foreclosing lender and other lienholders don’t get amount owed from foreclosure sale (and borrower/debtor isn’t paying), lienholders’ options:
- Junior Lienholder: Sue borrower on the promissory note (Borrower remains personally liable)
- Senior Lienholder: If lien is still attached to the property, foreclose on the bidder who holds title to the property after foreclosure sale

Question 19

Special Mortgage Priority Rules

Answer 19

● Junior interest did not get notice of foreclosure: If a junior interest holder was not given notice of the foreclosure, the junior interest is not wiped out by the foreclosure sale
● Senior interest was not recorded: Junior mortgagees who are bona fide encumbrancers (BFEs) have priority over earlier unrecorded interests who failed to record under applicable recording statute.
● Purchase Money Mortgage (PMM) Priority: PMMs have priority over more senior liens
● Deed in lieu of foreclosure: If borrower provides deed in lieu of foreclosure, then lender takes subject to junior liens

Question 20

Purchase Money Mortgages

Answer 20

What is a Purchase Money Mortgage (PMM)? (Casebook, p. 624)
- Traditional: Mortgage (loan) from seller (e.g., S sells to B and gets only part of the purchase price. S accepts promissory note, secured by mortgage on property)
- Modern: Mortgage (loan) from any lender for loan used to purchase property
Priority Rule: PMMs have priority over more senior liens

Question 21

How to determine whether a mortgage transfers to a new owner

Answer 21

When analyzing a property law exam problem, determining whether a mortgage transfers with property to a new owner involves a series of considerations. Follow these steps to address the issue:

1.Identify the parties and their interests:
Begin by identifying the original property owner (mortgagor), the mortgage lender (mortgagee), and the new property owner (grantee or purchaser). Understand the nature of the mortgage and the terms of the property transfer.

2.Determine if the mortgage is recorded:
Check whether the mortgage is properly recorded in the public records. This is important because, under notice and race-notice recording statutes, a subsequent purchaser may be protected from assuming a prior mortgage if they were a bona fide purchaser without notice of the mortgage at the time of purchase.

3.Assess the type of deed used in the property transfer:
Examine the type of deed used in the property transfer (e.g., general warranty deed, special warranty deed, or quitclaim deed) and its implications for the mortgage. A general warranty deed usually includes covenants against any encumbrances, while a special warranty deed may limit the warranties to the grantor’s period of ownership. A quitclaim deed provides no warranties and transfers the property “as is.”

4.Evaluate the concept of “subject to” vs. “assuming the mortgage”:
Determine whether the new property owner takes the property “subject to” the mortgage or “assumes” the mortgage. If the new owner takes the property “subject to” the mortgage, they are not personally liable for the debt, but the property remains encumbered, and the lender may foreclose if the debt is not paid. If the new owner “assumes” the mortgage, they become personally liable for the debt, and the original owner may be released from liability if the lender agrees.

5.Check for a due-on-sale clause:
Examine the mortgage agreement for a due-on-sale clause, which allows the lender to demand full payment of the outstanding loan balance if the property is sold or transferred. If such a clause exists, the lender may have the option to require the new owner to refinance or pay off the loan upon transfer.

6.Analyze applicable state laws and case law:
Review relevant state laws and any applicable case law to understand how courts in that jurisdiction have addressed similar situations. Laws and court decisions can vary across jurisdictions and may affect the outcome of your analysis.

In summary, determining whether a mortgage transfers with property to a new owner requires examining the terms of the mortgage and property transfer, the type of deed, the nature of the buyer’s obligations, and any applicable state laws and case law. The priority of the mortgage and its enforceability against a new owner depends on these factors and may be influenced by the recording statutes and the bona fide purchaser status of the new owner.