Learning Outcomes
This article explains the concepts of transferring mortgaged property where the transferee either assumes the mortgage obligation or takes the property subject to the mortgage. It clarifies the liability implications for both the original mortgagor and the transferee under each scenario and introduces the role of due-on-sale clauses. Upon completion, you will be able to distinguish between these transfer methods and analyze the resulting liabilities, important for answering MBE questions on mortgage transfers.
MBE Syllabus
For the MBE, your understanding of mortgages includes the rules governing the transfer of property already encumbered by a mortgage. This involves analyzing the liability of the original mortgagor and the transferee (grantee) based on the nature of the transfer. You should be prepared to:
- Distinguish between a transfer where the grantee "assumes" the mortgage and one where the grantee takes "subject to" the mortgage.
- Analyze the personal liability of the original mortgagor and the grantee after each type of transfer.
- Understand the concept of the original mortgagor becoming a surety upon an assumption by the grantee.
- Recognize the enforceability and effect of due-on-sale clauses.
- Determine the consequences of default and foreclosure in each scenario.
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
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Mortgagor conveys mortgaged property to Grantee "subject to" the existing mortgage held by Bank. Mortgagor makes no further payments, and Grantee also fails to make payments. Which statement is correct regarding Bank's rights upon default?
- Bank can sue only Grantee personally for the debt.
- Bank can sue only Mortgagor personally for the debt.
- Bank can sue both Mortgagor and Grantee personally for the debt.
- Bank can foreclose on the property but cannot sue Grantee personally for the debt.
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Mortgagor obtained a loan from Lender secured by a mortgage on Blackacre. Mortgagor later sold Blackacre to Buyer, who expressly agreed in the purchase contract and deed to "assume and agree to pay" the mortgage loan. Buyer subsequently defaulted. Which party is primarily liable to Lender for the debt?
- Mortgagor is primarily liable, and Buyer is secondarily liable.
- Buyer is primarily liable, and Mortgagor is secondarily liable as a surety.
- Mortgagor and Buyer are jointly and severally liable.
- Neither party is personally liable; Lender's only remedy is foreclosure.
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A clause in a mortgage instrument that permits the lender to demand full payment of the entire loan balance if the mortgaged property is transferred without the lender's permission is known as:
- An acceleration clause.
- An exculpatory clause.
- A due-on-sale clause.
- A subordination clause.
Introduction
When real property encumbered by a mortgage is sold or otherwise transferred, the existing mortgage remains on the property. The critical question for MBE purposes concerns the liability for the mortgage debt after the transfer. The transferee (the grantee or buyer) may either formally agree to take responsibility for the debt (assumption) or simply acquire the property with the mortgage remaining as a lien against it (subject to). The distinction significantly impacts the personal liability of both the original mortgagor and the transferee.
Assumption of the Mortgage
A grantee assumes the mortgage when they expressly or impliedly agree to take on personal liability for the mortgage debt. This promise is typically made to the mortgagor-seller, but the mortgagee (lender) is considered a third-party beneficiary of this promise.
Liability After Assumption
- Grantee Becomes Primarily Liable: Upon assumption, the grantee becomes primarily and personally liable to the lender for the mortgage debt. The lender can sue the grantee directly if the loan payments are not made.
- Original Mortgagor Becomes Secondarily Liable: The original mortgagor is not released from liability merely because the grantee assumed the debt. Instead, the original mortgagor becomes secondarily liable as a surety. If the grantee defaults, the lender can sue the original mortgagor, but the mortgagor then has a right of reimbursement against the defaulting grantee.
- Modification Discharges Original Mortgagor: If the lender and the assuming grantee subsequently modify the terms of the loan obligation (e.g., extending the payment period, changing the interest rate), the original mortgagor is completely discharged from liability as surety, unless the mortgagor consents to the modification.
Key Term: Assumption of Mortgage
An agreement by a grantee of mortgaged property to accept personal liability for the payment of the mortgage debt.
Exam Warning
Remember the surety relationship. If the lender modifies the loan agreement with the assuming grantee without the original mortgagor's consent, the original mortgagor is discharged. This is a common exam point.
Transfer "Subject To" the Mortgage
A grantee takes title subject to the mortgage if the deed merely recites the existence of the mortgage or is silent regarding liability. In this scenario, the grantee does not agree to be personally liable for the debt.
Liability When Taking "Subject To"
- Grantee Has No Personal Liability: The grantee is not personally liable for the mortgage debt. The lender cannot sue the grantee for payment if the loan defaults.
- Original Mortgagor Remains Personally Liable: The original mortgagor remains personally and primarily liable on the note.
- Foreclosure Risk: Although the grantee is not personally liable, the mortgage remains a lien on the property. If payments are not made (either by the grantee to protect their investment, or by the original mortgagor), the lender can foreclose on the property. The grantee risks losing the property through foreclosure if the debt is not paid.
Key Term: Subject To Mortgage
A transfer of mortgaged property where the grantee takes title subject to the existing mortgage lien but does not agree to assume personal liability for the mortgage debt.
Worked Example 1.1
Oliver purchased Blackacre for $300,000, financing $250,000 with a mortgage from Bank. Later, Oliver sold Blackacre to Priya for $320,000. The deed stated that the conveyance was "subject to the existing mortgage in favor of Bank." Priya made payments for a year but then defaulted. Bank foreclosed and the sale yielded $230,000, leaving a $15,000 deficiency on the loan balance. Can Bank recover the deficiency from Priya? Can Bank recover from Oliver?
Answer: Bank cannot recover the deficiency from Priya personally. Because Priya took the property "subject to" the mortgage, she did not assume personal liability for the debt. Bank can recover the $15,000 deficiency from Oliver personally. Oliver remained primarily liable on the original note even after transferring the property subject to the mortgage.
Due-on-Sale Clauses
Most modern mortgages contain due-on-sale clauses. These clauses give the lender the option to demand full payment of the entire outstanding loan balance immediately upon the transfer of any interest in the mortgaged property without the lender's written consent.
- Purpose: These clauses primarily allow lenders to prevent property transfers to potentially uncreditworthy buyers and to adjust interest rates upon transfer if market rates have increased since the loan origination.
- Enforceability: Under the federal Garn-St. Germain Depository Institutions Act, due-on-sale clauses are generally enforceable for most types of mortgages on real property, preempting state laws that might restrict their enforcement. There are limited exceptions, primarily for certain non-substantive transfers (e.g., transfer upon death of a joint tenant, transfer to a relative upon death of borrower, transfer into an inter vivos trust where borrower remains beneficiary).
Key Term: Due-on-Sale Clause
A provision in a mortgage or deed of trust allowing the lender to demand immediate payment of the entire loan balance if the mortgaged property is transferred without the lender's consent.
Revision Tip
Assume due-on-sale clauses are enforceable on the MBE unless a specific exception (like those under Garn-St. Germain) is mentioned or clearly applicable. The main impact is that a transfer might trigger the lender's right to accelerate the debt.
Key Point Checklist
This article has covered the following key knowledge points:
- Transferring mortgaged property results in either an "assumption" or taking "subject to" the mortgage.
- Assumption: Grantee becomes primarily personally liable; original mortgagor becomes secondarily liable (surety).
- Subject To: Grantee has no personal liability; original mortgagor remains personally liable; property remains subject to foreclosure.
- Lender modification of the loan with an assuming grantee discharges the original mortgagor (surety).
- Due-on-sale clauses generally allow the lender to demand full payment upon transfer.
- The Garn-St. Germain Act makes most due-on-sale clauses enforceable.
Key Terms and Concepts
- Assumption of Mortgage
- Subject To Mortgage
- Due-on-Sale Clause
