Mortgages

Question 1

Transfer of Mortgaged Property (visual)

Answer 1

Question 2

Transfer of Mortgage

Answer 2

A mortgage is an interest in real property given to a lender (mortgagee) to secure a debt.

The debtor (mortgagor) can freely transfer mortgaged property to a grantee unless the mortgage states otherwise. After the transfer, the mortgage remains attached to the property and the debtor remains personally liable for the mortgage debt.

But the grantee’s obligations depend on whether the grantee either:

• took subject to the mortgage – in which case the grantee does not agree to pay and is not personally liable for the debt OR
• assumed the mortgage – in which case the grantee expressly agrees to pay and becomes personally liable for the debt, while the debtor becomes secondarily liable as a surety.

Question 3

Does a grantee who takes real property subject to a mortgage personally liable for the debt?

Answer 3

A grantee who takes real property subject to a mortgage does not agree to pay and is not personally liable for the debt.

As a result, only the debtor is liable for any failure to make payments on the mortgage loan.

Question 4

Right of Redemption (Visual)

Answer 4

Question 5

What does the equitable right of redemption allow a debtor to do?

Answer 5

The equitable right of redemption allows a debtor to avoid foreclosure and regain clear title to the mortgaged property by paying the amount currently owed on the loan plus any accrued interest before the foreclosure sale.

When a debtor defaults on mortgage payments, the creditor (mortgagee) may initiate foreclosure proceedings to force the sale of the mortgaged property to satisfy the unpaid debt.

However, the debtor (mortgagor) can avoid foreclosure and regain clear title to the property by exercising the equitable right of redemption. This right allows the debtor to retain the property by paying the amount currently owed on the loan plus any accrued interest before the foreclosure sale, which the creditor must accept.*

*If the mortgage contains an acceleration clause, the debtor may have to pay the full amount of the outstanding debt (and any accrued interest) to exercise the equitable right of redemption.

Question 6

If the mortgage contains an acceleration clause, what may the debtor may have to do to exercise the equitable right of redemption?

Answer 6

If the mortgage contains an acceleration clause, the debtor may have to pay the full amount of the outstanding debt (and any accrued interest) to exercise the equitable right of redemption.

Question 7

Ways to Avoid Foreclosure

Answer 7

1) Equitable redemption*

• Mortgagor pays full amount of outstanding debt (as increased by acceleration clause) plus any accrued interest
• *Many states also recognize a statutory right of redemption that permits a mortgagor to reclaim the property after a foreclosure sale.

2) Deed in lieu of foreclosure

• Mortgagor conveys all interest in mortgaged property to mortgagee

3) Renegotiating debt

• Parties renegotiate terms of promissory note & mortgage

Question 8

What happens to any junior interests when the mortgagor executes a deed in lieu of foreclosure?

Answer 8

A deed conveying a mortgagor’s interest in the mortgaged property to a mortgagee in lieu of foreclosure allows the mortgagee to take immediate possession of the property without the formalities of a foreclosure sale.

Any junior interests remain attached to the property, and the mortgagee’s interest is extinguished unless it was reserved.

Question 9

The grantee of a mortgage is not personally liable for the debt unless the grantee expressly __________?

Answer 9

A mortgagor can freely transfer mortgaged land to a grantee but remains personally liable for the debt thereafter.

The grantee takes the land subject to the mortgage obligation without personal liability for the debt unless the grantee expressly agrees to assume the mortgage.

Question 10

Lien Priority on Real Property

Answer 10

Question 11

Mortgage - Priority

Answer 11

A mortgage is a lien on real property used to secure repayment of a debt.

A lender (mortgagee) may generally foreclose on a mortgage if the debtor (mortgagor) defaults on the mortgage loan.

A foreclosure terminates any interest in the foreclosed property that is junior (lower in priority) to the interest being foreclosed but does not affect any senior interest (higher in priority).

When no recording act is provided (as seen here), the “first in time, first in right” rule is used to prioritize interests.

Question 12

What rule is used to prioritze mortgage interests when no recording act is provided?

Answer 12

When no recording act is provided (as seen here), the “first in time, first in right” rule is used to prioritize interests.

Question 13

What happens to a senior mortgage when the junior mortgage forecloses?

Answer 13

The senior mortgage will remain attached to the property.

Question 14

For a mortgage to be enforceable, does the borrower have to be personally liable on the loan for which the mortgage serves as security?

Answer 14

NO.

A mortgage is enforceable even if the borrower is not personally liable on the loan for which the mortgage serves as security.

Question 15

Mortgage Theories

Answer 15

1) Lien theory (majority rule)

• Lender receives security interest in property.
• Mortgagor retains title & possession unless lender forecloses.
• In a lien-theory state, the lender cannot take possession of the land prior to foreclosure because the borrower (mortgagor) is considered the owner of the land during the term of the mortgage.

2) Title theory

• Lender receives legal title & mortgagor retains right of possession.
• Title reverts to mortgagor once debt is paid.
• In a title-theory state, the lender is theoretically* entitled to take possession of the land at any time—even if the mortgagor has not yet defaulted

3) Intermediate theory
* Mortgagor retains title & possession until default, then full title passes to lender without foreclosure.

Question 16

A lender’s (mortgagee’s) interest in mortgaged land depending on whether state is

1) Lien Theory
2) Title Theory

Answer 16

A lender’s (mortgagee’s) interest in mortgaged land depends on the mortgage theory followed by the state in which the property is situated:

l) Lien theory (majority rule) – the lender has only a security interest in the mortgaged land
2) Title theory – the lender has legal title to the land until the mortgage is fully satisfied.

Question 17

Mortgage Alternatives

Answer 17

1) Absolute deed

• Debtor gives deed to creditor with intent to secure loan (ie, equitable mortgage)
• Transfers title free of all liens and encumbrances—given with the intent to secure a debt is generally enforceable as an equitable mortgage.
  
  • But competing equities (e.g., good-faith purchaser) take precedence over an equitable mortgage.

2) Deed of trust
* Debtor gives deed of trust to third-party trustee as collateral for debt, & creditor can instruct trustee to foreclose upon default
3) Installment land contract
* Debtor agrees to buy land through installment payments & gets immediate possession, but seller keeps legal title until paid in full
4) Sale-leaseback
* Seller leases property from buyer immediately after sale, & seller’s rental payments function as repayments on loan
5) Equitable vendor’s lien
* Seller finances buyer’s purchase with equitable vendor’s lien when seller transfers title to buyer but purchase price not fully paid

Question 18

Purchase-Money Mortgage (PMM)

Answer 18

A purchase-money mortgage (PMM) is a mortgage granted to:

(1) the seller of real property

OR

(2) a third-party lender to the extent that the loan proceeds are used to acquire title to the real property.*

A PMM has superpriority over all other non-purchase-money-mortgages and liens that arose before the PMM—regardless of whether the PMM or those liens were recorded.

*A PMM can also arise when loan proceeds are used to construct improvements on the real property if the mortgage is given as part of the same transaction in which title is acquired.

Question 19

Transfer of Mortgage - Due on Sale Clause

What is the debtor’s liability on a promissory note if a due on sale clause is waived by lender?

Answer 19

A “due on sale” clause allows a lender to demand full payment of any remaining mortgage debt if the debtor transfers the mortgaged property without the lender’s written consent.

If this clause is waived, the debtor remains liable on the note—even after transferring the mortgaged property—until the debtor is released by the lender.

Question 20

Junior Interests - Omitted Party to the Foreclosure Action

Judicial Foreclosure

Answer 20

If the foreclosure is a judicial foreclosure, the holder of a junior interest must be given notice of the foreclosure and made a party to the foreclosure action. This provides the junior interest with an opportunity to redeem the property by paying off a senior interest.

If the holder of a junior interest is not made party to the action, her interest is not affected by the foreclosure action.

Question 21

Junior Interests - Omitted Party to the Foreclosure Action

“Power of Sale” Foreclosure

Answer 21

If the foreclosure is a “power of sale” foreclosure, most states that recognize this form of foreclosure do not require the foreclosing mortgagee to give notice to the holder of a junior interest, even though the sale will result in the destruction of the junior interest.

• However, the holder of a junior interest (as well as the mortgagor) can challenge a “power of sale” foreclosure that does not comply with the statutory procedures for such sales.
• A failure to adhere to these procedures may result in the voiding of the sale, even if the challenger does not establish harm that results from the failure.

Question 22

Junior Interests - Marshalling of Assets

Answer 22

Generally, a creditor whose debt is secured by a mortgage on multiple properties can elect which property to subject to a foreclosure sale.

However, when a senior mortgage is foreclosed and the mortgage covers multiple properties, the holder of a junior mortgage on some but not all of these properties can petition the court to apply the equitable doctrine of “marshalling of assets.”

• Under this doctrine, the holder of the senior mortgage may be compelled to first foreclose on the properties for which only that holder possesses a mortgage in order to protect the security interest of the holder of the junior mortgage, so long as it does not prejudice the interest of the holder of the senior mortgage or a third party.
• If there are multiple junior interests, then property subject to the more recently created interests is subject to foreclosure prior to property subject to the more remotely created interests (i.e., the “inverse order rule”).

Question 23

Mortgages with “Due-on-Sale” Clause

Answer 23

Mortgage documents may contain a due-on-sale clause, which is a federally enforceable provision that allows a lender to demand full payment of the remaining mortgage debt if the debtor (mortgagor) transfers the mortgaged property without the lender’s consent.

If the mortgage is not paid, then the lender can initiate foreclosure proceedings to recover any remaining debt.

Question 24

Due-on-sale clause affecting residential property

(common exceptions to enforceability)

Answer 24

• Devise, descent, or transfer to joint tenant upon death
• Transfer to spouse or child
• Transfer to ex-spouse in divorce
• Transfer to borrower’s living trust
• Creation of subordinate lien without occupancy rights
• Granting leasehold interest of less than 3 years without option to purchase

When a due-on-sale clause appears in a mortgage loan agreement, the mortgagee can demand payment in full of the remaining mortgage debt if the mortgagor transfers the mortgaged property without the mortgagee’s consent.

If the mortgagor cannot pay, then the mortgagee can foreclose on the mortgaged property to satisfy the unpaid debt.

However, certain transfers of residential real property are not subject to a due-on-sale clause—including a transfer to the mortgagor’s living trust.

This means that the homeowner was not required to pay the outstanding amount due on the loan after transferring ownership of her home to the living trust, and the thrift institution is not likely to succeed in its foreclosure action.

Question 25

Transfer of promissory note & mortgage

Answer 25

Both documents are transferred unless:

1) Transfer of note without mortgage

• expressly prohibited in note/mortgage
• forbidden by statute or public policy or
• increases mortgagor’s duties, burdens, risks

2) Transfer of mortgage without note*

• Transfer is void
  
  • JX are split as to this effect.

Question 26

To finance the purchase of real property, a borrower typically executes two documents that serve as evidence of the debt:

Answer 26

1) Promissory note – a formal “IOU” that sets forth the terms of the loan.
* It is the primary evidence of the debt and is not recorded in the deed records.
2) Mortgage – a lien that secures the loan by attaching the debt to a real property interest and providing a means of enforcement (e.g., foreclosure).
* It is recorded in the deed records to provide notice of an outstanding debt attached to the real property.
* A promissory note can be assigned to another (an assignee) independent of the mortgage.*
* The mortgage automatically transfers with the note once the note has been properly assigned (unless the parties agree otherwise).

A negotiable promissory note can be assigned by simply endorsing and delivering the note to the assignee.

• However, a nonnegotiable promissory note requires a separate assignment document to transfer ownership.

Question 27

Transfer of

Negotiable promissory note vs. Nonnegotiable promissory note

Answer 27

A negotiable promissory note can be transferred by endorsing and delivering the note to another,

BUT

A nonnegotiable promissory note requires that a separate document of assignment be executed to transfer ownership. Once properly assigned, the mortgage automatically transfers with the note.

Question 28

Is a donee who takes property that has been mortgaged entitled to assert the donor’s defenses against the mortgagee?

Answer 28

Yes.

A donee who takes property that has been mortgaged is entitled to assert the donor’s defenses against the mortgagee.

Note: By contrast, the purchaser of a property that has been mortgaged who assumes the mortgage cannot generally assert the defenses of mortgagor-seller against the enforcement of the mortgage if the purchase price reflects the assumption of the mortgage.

Otherwise, the purchaser would, by being permitted to avoid the assumed obligation, be unjustly enriched.

Question 29

Is enforcement of a mortgage subject to defenses that can be raised with respect to the obligation for which the mortgage serves as security?

Answer 29

Enforcement of a mortgage is subject to defenses that can be raised with respect to the obligation for which the mortgage serves as security.

• i.e., Statute of Limitations

Question 30

Are judgment creditors purchasers for value?

Answer 30

NO

Judgment creditors are not purchasers for value since the attachment of a judgment lien to a debtor’s property is merely security for a preexisting debt—not payment of value.

Question 31

Can a mortgage be given to secure a repayment of a debt owed by someone other than the mortgagor?

Answer 31

YES

A mortgage can be given to secure repayment of a debt owed by someone other than the mortgagor, and the mortgagee can foreclose on the mortgaged property if the debtor defaults.

Question 32

Proceeds from a foreclosure sale are typicall distributed in the following order of priority:

Answer 32

1) Expenses from the sale (eg, attorneys’ fees, court costs)
2) Mortgage being foreclosed
3) Junior liens, in order of lien priority
4) Debtor, if any surplus remains

Question 33

When a foreclosure sale results in a deficiency, from whome can the creditor can obtain a deficiency judgment?

Answer 33

When a foreclosure sale results in a deficiency, the creditor can obtain a deficiency judgment against:

(1) the original debtor and/or
(2) any party who has assumed the mortgage.

A debtor is free to sell mortgaged property unless the mortgage agreement states otherwise. After the sale, the mortgage remains attached to the property and the debtor remains personally liable for the debt secured by the mortgage.

But the buyer’s obligations with respect to the mortgage depend on whether he/she:

1) took the property subject to the mortgage – in which case the buyer does not agree to pay, and is not personally liable for, the debt (even if the buyer makes payments on the loan) or
2) assumed the mortgage – in which case the buyer expressly agrees to pay and becomes primarily liable for the debt, while the debtor becomes secondarily liable as a surety.

Question 34

1. What is the transferee-buyer’s liability on a mortgage if the dee is silent or ambiguous about such liability?
2. If transferee-buyer takes subject to the mortgage and there is a deficiency after the foreclosure sale and distributionof the sale proceeds, who is liable for the deficiency?

Answer 34

1. If a deed is silent or ambiguous about the transferee-buyer’s liability on the mortgage, then the buyer is considered to have taken the property subject to the mortgage obligation.
   * If the buyer takes title subject to the mortgage, he is not personally liable upon default, but the property may be sold at a foreclosure sale to satisfy the outstanding mortgage loan obligation.
2. If there is a deficiency after distribution of the sale proceeds, only the transferor-seller is personally liable for it.

Question 35

If a transferee-buyer assumes the mortgage and then defaults, is he personally liable for any deficiency?

Answer 35

YES.

If the buyer assumes the mortgage, then upon default, the buyer is personally liable for any deficiency.

Question 36

Can the terms of a mortgage of deed of trust waive the right to redeem the property as a matter of right before it is foreclosed upon by sale?

Answer 36

NO.

Until property that is subject to a mortgage or a deed of trust is foreclosed upon by sale, the borrower has a right to redeem the property by satisfying the obligation for which the property serves as security.

While this right may be waived after the borrower has defaulted, the terms of the mortgage or deed of trust cannot waive this right as a matter of course.

Example from PQ5: Consequently, because the clause in the deed of trust in question is invalid and the court should permit the auto mechanic to regain title to the garage by paying the loan obligation in full.

• The term that required redemption of the garage within three month was invalid as a clog on his equitable right to redeem the property prior to a foreclosure sale.

Question 37

Equity of Redemption

Deed in Lieu of Foreclosure

Answer 37

a. Deed in lieu of foreclosure

In lieu of foreclosure, a mortgagor may convey all interest in the property to the mortgagee (“deed in lieu of foreclosure”). This permits the mortgagee to take immediate possession of the property without any further legal formalities, but it requires the consent of both the mortgagor and the mortgagee. The mortgagee generally may reserve the right to pursue a deficiency as measured by the difference between the outstanding mortgage obligation and the fair market value of the property against the mortgagor, but the mortgagor may bring an equitable action to set aside the conveyance if it is not reasonable and fair.

b. Clogging the equity of redemption

A mortgagor may waive his right to redeem after the mortgage is executed in exchange for consideration. However, courts routinely reject attempts by the mortgagee to deny the mortgagor this right (i.e., to “clog” the equity of redemption) prior to default, such as by the inclusion of a waiver clause in the mortgage.

c. Redemption by others

In addition to being exercised by the mortgagor, the right of redemption may also be exercised by anyone whose right to mortgaged property stems from the mortgagor’s interest in the property, such as an heir, a devisee, a purchaser, a donee, or a tenant, as well as a junior lienholder to whom the mortgagor has granted a second mortgage that is subordinate to the mortgage that is redeemed.

Example PQ5: When the bank accepted the couple’s deed in lieu of foreclosure without reserving the right to foreclose, it extinguished the bank’s mortgage on the house. However, this transaction did not affect the savings and loan association’s mortgage on the house. The bank took title to the house subject to the savings and loan association’s mortgage.

Question 38

What is the residential real property exemption to an acceleration clause?

Answer 38

Generally, an acceleration clause (due-on-sale clause) in a mortgage loan document is enforceable.

However, federal law provides a residential real property exemption, exempting certain transfers of residential real property from the requirement that states give effect to an acceleration clause.

Among the exempt transfers is a transfer by the mortgagor-borrower to her living trust.

Question 39

1) Is the transferee of mortgaged property who assumes the mortgage obligation personally liable to the mortgagor?
2) Can a transferee of mortgaged property take possession of the property subject to a mortgage without assuming personal liability for the mortgage obligation?

Answer 39

1) YES.
* A transferee of mortgaged property who assumes the mortgage obligation is personally liable to the mortgagor.
2) YES.
* A transferee of mortgaged property may take possession of the property subject to the mortgage without assuming personal liability for the mortgage obligation.

Question 40

Who has priority:

Seller’s PMM vs. 3rd Party lender PMM?

Answer 40

A seller’s purchase-money mortgage generally has priority over a purchase-money mortgage given to a third-party lender by a buyer to aid the buyer in acquiring the property from the seller.

The priority of third-party purchase-money mortgages is determined chronologically, subject to any other applicable exception.

Question 41

When does the modification of a senior mortgage prejudice a junior mortgage?

Answer 41

Generally, the modification of a senior mortgage does not forfeit the mortgage’s priority over a junior mortgage except to the extent that the mortgage prejudices the junior mortgage.

• In such a case, the senior mortgagee subordinates its interest only as to the modification (i.e.,: here, the additional $25,000 wedding loan), while the original mortgage remains superior.
  
  • The increase in the amount of the bank’s mortgage here prejudiced the junior mortgage by creating a greater risk that the value of the property would not be sufficient to cover the credit union’s loan, as proved to be the case.
  • Consequently, although the bank did not lose its priority with respect to the residential purchase loan, the mortgage modification resulted in the credit union’s loan having priority over the bank’s wedding loan.
• example from MBE Practice Exam #1

Question 42

Priority of Interests

Mortgage Modifications and Replacements

Answer 42

A senior mortgagee who enters into an agreement with the mortgagor to modify the mortgage or the obligation it secures subordinates his interest to a junior mortgagee’s interest to the extent that the modification is materially prejudicial to the junior mortgagee’s interest.

• The senior mortgagee’s interest otherwise remains superior to the junior mortgagee’s interest.

Similarly, when a senior mortgagee releases a mortgage and, as part of the same transaction, replaces it with a new mortgage, the new mortgage retains the same priority as the former mortgage, except to the extent that any change in the terms of the mortgage or the obligation it secures is materially prejudicial to the holder of a junior interest in the real estate.

Question 43

How is money from a foreclosure sale applied?

Answer 43

1. costs associated with the sale
2. mortgage obligation being foreclosed
3. morgage obligations owed to all junior interest holders

***However, a senior mortgagee who enters into an agreement with the mortgagor to modify the mortgage or the obligation it secures subordinates his interest to a junior mortgagee’s interest to the extent that the modification is materially prejudicial to the junior mortgagee’s interest.

• The senior mortgagee’s interest otherwise remains superior to the junior mortgagee’s interest.