Mortgages

Question 1

What is a Mortgage?

Answer 1

Because real estate is so expensive, most people can’t afford to pay cash for it. Most people go to a bank or other lending institution for a loan. To secure the debt, the borrower gives the lender a mortgage (along with a promissory note representing the loan) on the property. If the loan isn’t paid, the lender may foreclose the mortgage. Foreclosure involves selling the property to pay the debt.

Question 2

Mortgagor and Mortgagee

Answer 2

The borrower is called the mortgagor, and the lender is the mortgagee. It’s important to commit these to memory so that you don’t take valuable time sorting them out on your exam.

Question 3

Promissory Note and Mortgage

Answer 3

The mortgage transaction involves two documents: the promissory note and the mortgage. The note is the mortgagor’s personal obligation. In other words, foreclosing on the property is not the mortgagee’s only recourse in the event of default—they can sue the mortgagor on the note for payment of the debt if the mortgagor quits paying. The mortgage is the agreement that says that if the mortgagor quits paying, the land can be sold to pay the mortgagee.

Question 4

Purchase Money vs. Non-Purchase Money Mortgages

Answer 4

Purchase Money Mortgage =a loan that enables a borrower to buy a home

Non-purchase Money Mortgage = a loan on the home as collateral but not used to buy it

Question 5

Transfer by Mortgagee (Lender)

Answer 5

For the bar exam, you need to know that a mortgagee may transfer their interest and how that is accomplished. The creditor-mortgagee can transfer her interest by:

Indorsing the note and delivering it to the transferee, or

Executing a separate document of assignment

The general rule is that a mortgagee can freely transfer the note, and the mortgage will always follow the note it secures.

Question 6

Transfer by Mortgagor - Assumption or Subject To

Answer 6

When a mortgagor transfers the property, the buyer either assumes the mortgage or takes the property subject to the mortgage. What’s the difference?

Assumption = If a grantee assumes the mortgage, they’re agreeing to be personally liable on the mortgage note. If there’s a deficiency, the bank could sue both the assumptee and original borrower for the deficiency.

Take Subject To = If they take the property subject to the mortgage, they are not agreeing to personal liability; the mortgagee’s only recourse is foreclosure (they cannot maintain a suit against the grantee).

Generally, when a mortgagor transfers title to the property, the grantee automatically takes the property subject to the mortgage. The grantee will not be personally liable on the mortgage unless they specifically assume the mortgage.

Question 7

Due-on-Sale Clauses

Answer 7

Technically, a mortgagor doesn’t need the mortgagee’s permission to transfer the mortgage. In reality, most mortgages contain a clause that allows the mortgagee to demand full payment of the mortgage loan if the mortgagor transfers the mortgage without the mortgagee’s consent. In other words, if the borrower sells the property to someone else, the loan becomes due upon the sale of that property, hence the name “due on sale” clause.

Question 8

Defenses and Discharge

Answer 8

Defense to Underlying Obligation = if the underlying loan is unenforceable, so is the mortgage. Defenses to the underlying obligation are defenses to enforcement of the mortgage and include duress, mistake, fraud, and other contract defenses.

Discharge = A mortgagee can’t foreclose if the mortgage is discharged. Acts that discharge the mortgage include full payment of the debt, merger of the mortgagor and mortgagee’s interests, and a deed in lieu of foreclosure (mortgagor deeds property to mortgagee usually in exchange for release from the debt).

Question 9

Consumer Protection

Answer 9

After debtor has defaulted, creditor is obliged in good faith to consider loan modification or some other alternative to foreclosure, like a workout of some sort. Creditor not permitted to file foreclosure action in court while such request is still pending by the debtor.

Question 10

Foreclosure: Possession and Redemption

Answer 10

Foreclosure is the process by which the mortgaged property is sold at auction, and the mortgagor’s interest in it is terminated. The lender can bid, and often does, at the foreclosure sale.

Possession Before Sale: Most states are lien theory states, meaning that they view a mortgage as lien. (In title theory states, the mortgagee actually holds legal title until the mortgage is fully paid.) In lien theory states, the mortgagee is not entitled to possession of the property before foreclosure. The mortgagee may take possession, though, if the mortgagor either consents to it or has abandoned the property.

Redemption: Redemption refers to the mortgagor’s ability to recover the property once they are in default. There is redemption in equity, which allows the mortgagor to redeem the property before the foreclosure sale, and a statutory right of redemption, which is recognized in about half the states and allows the mortgagor to redeem for a period of time after the foreclosure sale. Equitable redemption is acceptable everywhere. Debtor has right to redeem the sale before the foreclosure. To exercise equitable redemption when the mortgage agreement doesn’t have an acceleration clause, a debtor prior to foreclosure can pay off any missed payment plus interest and costs. If there is an acceleration clause to redeem the full balance + interest + costs, then debtor must pay it all.

Debtor CANNOT waive the right to redeem. That’s called CLOGGING the equity of redemption. It is PROHIBITED. Won’t allow debtor to waive any rights in event of default.

Question 11

Statutory Redemption

Answer 11

Debtor must pay the foreclosure sale price after the foreclosure to get their house back. Not the original debt. In most states, during the statutory period, the debtor has the right to possession. It’s a generous reprieve for the financially distressed debtor.

Question 12

Foreclosure Sale

Answer 12

When Blackacre is sold, proceeds go to satisfy the debt. If those proceeds come up short, there is a deficiency. Mortgagee will bring deficiency action against debtor in states without antideficiency statutes. If there is a surplus, junior liens are paid off in order of priority, and if there is still more left after that, it goes to the debtor.

Waterfall: Home is worth 50k. Mortgage1 = 30k, Mortgage2 = 15k, Lien3 = 10k. The home sells for 50k. Who gets what? Mortgagee1 gets 30k, Mortgagee2 gets 15k, and Lienholder3 gets 5k, not the full 10k he was owed.

If instead the house sold for 60k, then all the creditors get paid and the debtor gets the leftover 5k remaining.

Question 13

Priorities

Answer 13

Priority among interests in foreclosure is the most heavily tested aspect of mortgages. The default rule is that the priority of a mortgage depends on when it was placed on the property. First in time, first in right again.

A buyer at a foreclosure sale takes the title as it existed when the foreclosed mortgage was placed on the property. All interests senior to that one remain on the property, and all interests junior to that one are extinguished. Those interests include junior mortgages, liens, leases, easements, and all other types of interests.

Once foreclosure has occurred, junior lienholders can no longer look to Blackacre to satisfy the debt. The junior lienholders are necessary parties. Is the debtor also a necessary party to the foreclosure action? YES especially if the lender thinks it will need a deficiency judgment against the debtor. Debtor is a necessary party.

Failure to include a necessary party results in the preservation of the junior creditor’s claim despite the fact of the foreclosure. So if the necessary party isn’t joined, his mortgage remains on the land. Foreclosure does not have the power to compromise or affect any interest senior to that of the mortgage being foreclosed. A buyer takes subject to those senior interests. The buyer isn’t personally liable, but if not paid off, the senior creditor could foreclose on the land even though it’s now in the hands of that foreclosure sale buyer who bought at the foreclosure sale.

Question 14

After-Acquired Property / Floating Lien

Answer 14

When the loan is undercollateralized at its inception, a bank might give you a loan more than you deserve right now because it expects to get a security interest in your future realty, aka after-acquired property clause.

C1 records the mortgage note with an after acquired realty clause. Six months later, C2 lends O $50,000 to enable O to acquire a parcel known as Blueacre, taking back a security interest in Blueacre and recording that interest. Subsequently, O defaults on all outstanding obligations. All that he has left is Blueacre. Who has first priority in Blueacre? C2 does, the second one, even though the floating lien applies to Blueacre. The purchase money mortgagee, C2, gets first prio in the property it financed. That’s fair because without a purchase money mortgagee, the debtor would not have acquired the property at all.

Question 15

Subordination Agreements

Answer 15

This is when creditors clarify or change the priority relationships between each other. So maybe a senior creditor is willing to subordinate themselves to the junior creditor in exchange for something else.

Question 16

Priorities in Foreclosure

Answer 16

Step 1: Figure out Priority of Interests
The general rule is that the first-in-time has highest priority. But there are exceptions, especially involving recording statutes. You will have to refer to the recording statute to figure out step 1. But you MUST do step 1 first. You have to know the priority order of interests before doing anything else.

Step 2: Which Interest is Being Foreclosed?
Only one interest is foreclosed at a time. Several mortgage and lien holders might start the foreclosure process at the same time, but only one will actually go all the way through the foreclosure process, and the question will tell you which one that is.

Step 3: Which Interests are Superior to the One Being Foreclosed?
Locate any interests that rank higher on the priority list than the one that was foreclosed. Set these interests aside. Nothing is going to happen to them. They will survive the foreclosure. These senior interests will not get any money from the foreclosure, but they don’t need it—they get to keep their mortgages, so they’re happy.

Step 4: Which Interests are Inferior to the One Being Foreclosed?
Locate any interests with lower priority than the one being foreclosed. The foreclosing party must give these interests notice of the foreclosure. If the exam question specifically says that the holder of a junior interest did not receive notice of the foreclosure, treat that interest as a senior interest. If a holder of a junior mortgage or other interest didn’t get notice, that interest will survive the foreclosure.

Step 5: Distribute Proceeds
Distribute the proceeds of the foreclosure sale to the foreclosing party and then group the junior interests in order of their priority among themselves. (Remember senior interests do not receive proceeds because their interest remains on the land.) So, let’s say the foreclosure sale generates $200,000. The mortgage that was foreclosed was owed $150,000. That mortgagee gets repaid in full—$150,000 out of that $200,000. Let’s say the next priority interest is a mortgagee owed $60,000. Uh oh, we’re short. Too bad. That mortgagee gets the remaining $50,000 from the sale, but that’s basically it. They lose their lien, and they don’t get any more from the sale. They have a $10,000 deficiency. All interests junior to that one will have deficiencies for the full amount owed to them.

Step 6: Deficiency Suits
Any junior interest holder who did not receive full payment from the proceeds of the foreclosure sale is entitled to bring suit against the debtor for the amount still owed. That amount owed is called the deficiency. (Since the debtor is having his property foreclosed upon, the chances of recovery on deficiency suits can be pretty slim.)

Step 7: Distribute Excess Funds (If Any)
If, instead of a deficiency, there is a surplus of funds after a foreclosure sale, that surplus belongs to the debtor.

Question 17

Summary

Answer 17

So, when the dust clears, what’s left? The old property owner no longer owns the property. We have a new owner, who bought the property at the foreclosure sale. Many of the mortgages and liens are gone (including the one that was foreclosed and any inferior interests who received notice of the foreclosure). BUT, the liens that were senior to the interest foreclosed stick around, and the new owner owns the property subject to those interests, meaning that those interests too could be foreclosed at some point in the future if they go into default.