Key Takeaways
- A mortgage is a security interest in land; the debt is the underlying obligation
- Lien theory states: mortgagee holds only a lien; mortgagor retains title (majority)
- Title theory states: mortgagee holds legal title until mortgage is paid
- Equity of redemption allows mortgagor to pay and reclaim property until foreclosure sale
- Recording priority typically determines which mortgage is paid first from sale proceeds
Mortgages
A mortgage is a security interest in real property given to secure payment of a debt. The property owner is the mortgagor; the lender is the mortgagee.
Legal Theories
| Theory | Title Holder | Effect |
|---|---|---|
| Lien Theory (Majority) | Mortgagor retains title | Mortgage creates only a lien |
| Title Theory | Mortgagee holds legal title | Mortgagor has equity of redemption |
| Intermediate Theory | Mortgagor has title unless default | Title transfers upon default |
Practical differences arise regarding:
- Mortgagee's right to possession
- Effect on joint tenancy
- Rights of parties during default
Creation
Requirements:
- Debt: Valid underlying obligation
- Voluntary transfer: Mortgagor must willingly grant security
- Description: Sufficient description of property
- Writing: Statute of Frauds applies
- Delivery: Mortgage must be delivered to mortgagee
Deed of Trust
Alternative form where property is conveyed to trustee who holds until debt paid. On default, trustee can sell without full judicial foreclosure (in many states).
Rights of Parties
Mortgagor's Rights:
- Possession (lien theory states)
- Rents and profits until foreclosure
- Equity of redemption: Right to pay debt and reclaim property
- Right to cure default (statutory in many states)
Mortgagee's Rights:
- Security interest in property
- Right to foreclose on default
- Right to proceeds from sale (up to debt amount)
- Right to be first paid if property sold (priority permitting)
Transfer of Interests
Transfer by Mortgagor
Mortgagor can transfer property subject to the mortgage:
| Type | Effect on Transferee |
|---|---|
| Subject to mortgage | Transferee not personally liable; property remains security |
| Assumption | Transferee becomes personally liable for debt |
Due-on-Sale Clause: Allows lender to accelerate debt upon transfer.
Transfer by Mortgagee
Mortgage follows the debt. If debt is transferred:
- Mortgage automatically transfers with it
- Assignee takes subject to defenses against original mortgagee (unless HDC)
Priorities
General Rule: "First in time, first in right"
Recording acts determine priority among mortgages.
Purchase Money Mortgage (PMM)
A PMM given to secure purchase price of property has super-priority over other claims arising through the purchaser, even if recorded later (same-day recording race).
Types of PMM:
- Vendor PMM: Seller finances purchase
- Third-party PMM: Lender provides funds to purchase
If both exist, vendor PMM typically has priority.
Subordination Agreements
Mortgagees can contractually agree to change their priority positions.
Future Advances
Mortgages securing future advances:
- Obligatory advances: Priority relates back to original mortgage date
- Optional advances: Priority only if mortgagee had no notice of intervening lien
Foreclosure
Types of Foreclosure:
| Type | Process |
|---|---|
| Judicial foreclosure | Court-supervised sale |
| Power of sale | Trustee or mortgagee sells without court |
| Strict foreclosure | Mortgagee keeps property (rare, limited) |
Equity of Redemption
Right to redeem property by paying off debt before foreclosure sale.
- Cannot be waived in mortgage (clogging the equity)
Statutory Redemption
Some states allow redemption after foreclosure sale (usually 6 months to 1 year).
Distribution of Proceeds:
- Foreclosure costs and fees
- Foreclosing mortgage principal and interest
- Junior liens in order of priority
- Surplus to mortgagor
Deficiency
If sale proceeds < debt owed, mortgagee may seek deficiency judgment (personal liability). Some states limit deficiency judgments.
Discharge and Termination
Satisfaction:
When debt is paid, mortgagee must release mortgage:
- Record satisfaction/release
- Failure to release may create liability
Merger:
If mortgagee acquires the property, mortgage may merge with title (unless mortgagee intends to keep it alive to protect against junior liens).
Anti-Deficiency Rules
Some states (especially after 2008 crisis) limit deficiency judgments:
- Purchase money loans on primary residences
- Non-judicial foreclosures (in some states)
One-Action Rule: Some states require single action for debt and foreclosure.
BAR EXAM CRITICAL RULES
Effect on Joint Tenancy (HEAVILY TESTED)
| Theory | Effect of Mortgage on Joint Tenancy |
|---|---|
| Lien Theory (majority) | Mortgage does NOT sever joint tenancy; severance only if foreclosure sale occurs |
| Title Theory (minority) | Mortgage SEVERS joint tenancy (title passes to mortgagee) |
Critical Risk: If mortgaging joint tenant dies before foreclosure, mortgage is extinguished by right of survivorship (in lien theory states).
Foreclosure sale always severs joint tenancy regardless of theory.
Modification of Senior Mortgage
When senior mortgage is modified, junior mortgage prevails over modification only to the extent it materially prejudices the junior.
| Modification | Effect on Junior Priority |
|---|---|
| Increasing principal | Junior gains priority to extent of increase |
| Increasing interest rate (if originally fixed) | Junior gains priority to extent of increase |
| Extension of maturity date | Does NOT prejudice junior; senior retains priority |
| Rescheduling installments | Does NOT prejudice junior; senior retains priority |
Installment Land Contracts
Buyer takes possession; seller retains title until all payments made.
| Feature | Rule |
|---|---|
| Default | Contract usually provides for forfeiture of all installments |
| Grace period | Many states grant buyer period to cure default |
| Waiver of timeliness | If seller accepts late payments, must give written notice to reinstate |
| Foreclosure requirement | Some states require foreclosure proceeding instead of forfeiture |
Absolute Deed as Mortgage (Deed Absolute)
When debtor issues deed that appears absolute but has side agreement to reconvey upon repayment.
Court treats as mortgage if extrinsic agreement proven.
Parol evidence is ALWAYS admissible to show deed absolute on its face is intended as mortgage.
Effect: Protects debtor's equity of redemption rights.
Marshaling of Assets
Two Funds Doctrine: When senior creditor has lien on TWO properties and junior has lien on only ONE, court may require senior to foreclose on property NOT subject to junior lien first.
Inverse Order of Alienation: When mortgaged property sold in parcels, foreclosure proceeds from parcels in reverse order of sale (last sold first).
Direct Order of Alienation: When grantee assumes mortgage, grantee's land is sold first.
Novation vs. Assumption
| Transaction | Original Mortgagor Liability |
|---|---|
| Assumption only | Remains secondarily liable |
| Novation | Released from liability (requires lender agreement) |
For novation, transferee and mortgagee must agree that transferee assumes AND original mortgagor is released.
Suretyship Rights After Assumption
When grantee assumes mortgage:
- Exoneration: Grantor can get court order compelling grantee to pay
- Reimbursement: If grantor pays after assumption, can sue grantee
- Subrogation: Grantor can pay debt and be subrogated to mortgage/note
Deed in Lieu of Foreclosure
Mortgagee accepts deed to property instead of foreclosing.
CRITICAL DIFFERENCE: Mortgagee takes deed with all junior mortgages still attached.
Mortgagee steps into shoes of mortgagor (subject to junior liens).
Different from foreclosure which extinguishes junior interests.
Prepayment Rights
- No absolute right to prepay mortgage early—must be in mortgage terms
- Prepayment penalty/fee is valid—compensates creditor for lost interest income
Parties to Foreclosure
Junior mortgage is NOT extinguished if junior mortgagee:
- Not made defendant in judicial proceeding
- Does not receive notice of foreclosure sale
Senior interests not participating are NOT affected by sale.
Waste by Mortgagor
Mortgagor commits waste if, without consent:
- Fails to pay property taxes with priority over mortgage
- Makes physical changes reducing property value
- Fails to maintain and repair reasonably
- Fails to comply with mortgage covenants
- Retains rents mortgagee entitled to
Mortgagee Remedies: Foreclosure, injunction, damages (limited to extent waste impaired security).
Bank holds a first mortgage on Homeowner's property. Homeowner defaults. Bank forecloses and the property sells for $200,000. Bank is owed $150,000; Finance Company holds a second mortgage for $100,000. How are proceeds distributed?
Buyer purchases property using a loan from Bank and gives Bank a mortgage. The mortgage is recorded on April 1. On March 15, before the purchase, Contractor had filed a mechanic's lien for $10,000 for work done on the property. Which lien has priority?
Mortgagor defaults on payments. Before the foreclosure sale occurs, Mortgagor tenders full payment of the debt plus costs. What is the result?
Alice and Bob own Blackacre as joint tenants with right of survivorship. The jurisdiction follows the lien theory of mortgages. Bob executes a mortgage on his interest in Blackacre to First Bank to secure a $100,000 loan. Bob dies before any foreclosure proceedings occur, leaving his daughter Carol as his sole heir. First Bank seeks to foreclose on the mortgage. What is the most likely result?
Developer obtains a first mortgage from First Bank for $500,000, which is properly recorded. One year later, Developer obtains a second mortgage from Second Bank for $200,000, also properly recorded. Subsequently, Developer and First Bank agree to modify the first mortgage by increasing the principal to $600,000 and extending the maturity date by five years. Second Bank was not notified of and did not consent to the modification. If Developer defaults and the property sells at foreclosure for $650,000, how should the proceeds be distributed?
Owner grants a first mortgage to First Bank for $300,000, which is recorded. Owner then grants a second mortgage to Second Bank for $100,000, also recorded. Owner defaults on both loans. Rather than foreclosing, First Bank agrees to accept a deed to the property from Owner in lieu of foreclosure. After receiving the deed, First Bank discovers the property is worth only $350,000. What is First Bank's position regarding Second Bank's mortgage?