Mortgages/security devices - By mortgagor

Learning Outcomes

This article examines the rights and liabilities associated with the mortgagor's interest in property used as security for a debt. After reviewing this material, you will be able to distinguish between a transfer "subject to" a mortgage and an "assumption" of a mortgage, analyze the continuing liability of the original mortgagor after a transfer, understand the effect of due-on-sale clauses, and identify the mortgagor's rights of redemption, equipping you to answer related MBE questions.

MBE Syllabus

For the MBE, you are required to understand the principles governing the transfer of property subject to a mortgage or other security device by the mortgagor. You should be prepared to:

• Analyze the transfer of the mortgagor's interest, including the concept of taking "subject to" versus "assuming" the mortgage.
• Determine the liability of the original mortgagor after the property has been transferred.
• Assess the personal liability of the transferee (grantee) based on whether they assumed the mortgage.
• Understand the operation and enforceability of "due-on-sale" clauses.
• Distinguish between the equity of redemption and statutory rights of redemption.

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.

1. A mortgagor sells property subject to a mortgage to a grantee. The grantee makes several payments but then defaults. The lender forecloses and the sale yields less than the outstanding debt. Against whom may the lender recover the deficiency?
   1. Only the grantee.
   2. Only the original mortgagor.
   3. Both the original mortgagor and the grantee.
   4. Neither the original mortgagor nor the grantee.
2. A buyer purchases property from a seller and expressly agrees in the purchase contract and deed to pay the existing mortgage debt held by Lender. If the buyer defaults, which statement is most accurate regarding Lender's rights?
   1. Lender can only sue the seller.
   2. Lender can only sue the buyer.
   3. Lender can sue either the buyer or the seller.
   4. Lender must foreclose on the property before suing anyone personally.
3. A clause in a mortgage agreement stating that the entire loan balance becomes due if the mortgagor transfers the property without the lender's consent is known as:
   1. An acceleration clause.
   2. An estoppel by deed clause.
   3. A due-on-sale clause.
   4. A subordination clause.

Introduction

A mortgagor, the property owner who borrows money, retains both title and the right to possession of the mortgaged property (in most jurisdictions). The mortgagor’s interest, often called "equity," is transferable just like any other interest in land. However, any transfer is made subject to the mortgage, which remains attached to the property. This article focuses on the consequences of such transfers, including the liabilities of the original mortgagor and the transferee, the impact of assumption agreements, and the mortgagor's rights to redeem the property.

Transfer of Mortgagor's Interest

The mortgagor can freely transfer the mortgaged property by sale, gift, or devise. However, the mortgage remains on the property, and the transferee takes the property subject to the mortgage lien, unless the lender has been paid off before or at the closing of the transfer. The key distinction in transfers concerns the personal liability of the transferee for the mortgage debt.

Transfer "Subject To" the Mortgage

If the deed states that the transferee takes title "subject to" the mortgage (or is silent regarding the mortgage), the transferee is not personally liable for the mortgage debt. The property itself is still subject to the mortgage lien and can be foreclosed upon if payments are not made. However, if the foreclosure sale does not yield enough to cover the outstanding debt, the lender cannot pursue the transferee for a deficiency judgment.

Key Term: Subject to the Mortgage A transfer of mortgaged property where the transferee takes title subject to the existing mortgage lien but does not agree to be personally liable for the associated debt. The original mortgagor remains personally liable.

The original mortgagor remains personally liable on the associated promissory note after a "subject to" transfer. If the transferee defaults and the foreclosure sale results in a deficiency, the lender can sue the original mortgagor for the shortfall.

Assumption of the Mortgage

A transferee "assumes" the mortgage when they expressly agree, usually in the deed or purchase agreement, to accept personal liability for the mortgage debt.

Key Term: Assumes the Mortgage A transfer of mortgaged property where the transferee expressly agrees to accept personal liability for the existing mortgage debt. Both the original mortgagor and the assuming transferee are personally liable.

When a mortgage is assumed:

1. The transferee (assuming grantee) becomes primarily and personally liable to the lender for the mortgage debt. The lender can sue the transferee directly if payments are defaulted.
2. The original mortgagor becomes secondarily liable as a surety. The lender can still sue the original mortgagor if the assuming grantee defaults.
3. If the lender and the assuming grantee later modify the loan terms, the original mortgagor (as surety) is generally discharged from liability.

Worked Example 1.1

Owner mortgaged Blackacre to Bank for $100,000. Owner later sold Blackacre to Buyer for$150,000. The deed stated that Buyer took title "subject to the existing mortgage to Bank." Buyer made payments for a year but then defaulted. Bank foreclosed, and the property sold for $90,000, leaving a$10,000 deficiency (ignoring costs and interest). Can Bank recover the $10,000 deficiency from Buyer?

Answer: No. Buyer took title "subject to" the mortgage, meaning Buyer did not agree to be personally liable for the debt. While Bank could foreclose on the property, it cannot sue Buyer for the deficiency. Bank's only recourse for the deficiency is against the original mortgagor, Owner.

Worked Example 1.2

Same facts as above, but the deed stated that Buyer "assumes and agrees to pay the existing mortgage to Bank." Buyer defaults, and the foreclosure sale yields $90,000, leaving a$10,000 deficiency. From whom can Bank recover the deficiency?

Answer: Bank can recover the $10,000 deficiency from either Buyer or Owner. Buyer is primarily liable because she assumed the mortgage debt. Owner remains secondarily liable as a surety. If Bank recovers from Owner, Owner generally has a right of reimbursement against Buyer.

Due-on-Sale Clauses

Most modern mortgages contain a "due-on-sale" clause. This clause allows the lender to demand full payment of the remaining loan balance immediately if the mortgagor transfers her interest in the property without the lender's consent.

Key Term: Due-on-Sale Clause A provision in a mortgage agreement that permits the lender to accelerate the due date of the entire outstanding loan balance if the mortgaged property is transferred by the mortgagor without the lender's consent.

These clauses are generally enforceable under federal law and are routinely upheld by courts. Their purpose is to allow the lender to reassess the interest rate or the creditworthiness of the new owner upon transfer.

Mortgagor's Right to Redeem

Even after default, the mortgagor retains the right to reclaim the property by paying the debt. There are two types of redemption rights:

1. Equity of Redemption: This is a common law right that allows the mortgagor to prevent foreclosure by paying the full amount of the outstanding debt (including interest and costs) at any time before the foreclosure sale occurs. If the mortgage contains an acceleration clause (making the entire balance due on default), the mortgagor must pay the full accelerated balance to redeem. This right cannot be waived in the mortgage instrument itself ("clogging the equity of redemption" is prohibited).
2. Statutory Redemption: About half the states provide a statutory right to redeem after the foreclosure sale has occurred. This right lasts for a fixed period (e.g., six months to a year). The amount required to redeem under statute is typically the foreclosure sale price, not the original debt amount. This right allows the mortgagor (and sometimes junior lienholders) to effectively buy back the property from the foreclosure sale purchaser.

Key Term: Equity of Redemption The mortgagor's common law right to prevent foreclosure by paying the full mortgage debt, plus accrued interest and costs, before the foreclosure sale.

Revision Tip

Carefully distinguish between the equity of redemption (pre-foreclosure) and statutory redemption (post-foreclosure). Know which applies and what amount must be paid (full debt vs. sale price). Remember that "clogging" the equity of redemption is not permitted.

Key Point Checklist

This article has covered the following key knowledge points:

• A mortgagor can transfer mortgaged property, but the mortgage lien remains.
• A transferee taking "subject to" a mortgage is not personally liable for the debt.
• A transferee "assuming" a mortgage becomes personally liable, usually primarily.
• The original mortgagor typically remains secondarily liable after an assumption, unless released or discharged (e.g., by modification).
• Due-on-sale clauses permit lenders to demand full payment upon transfer without consent.
• The equity of redemption allows the mortgagor to prevent foreclosure by paying the full debt before the sale.
• Statutory redemption (where available) allows the mortgagor to repurchase the property after the foreclosure sale by paying the sale price.

Key Terms and Concepts

• Subject to the Mortgage
• Assumes the Mortgage
• Due-on-Sale Clause
• Equity of Redemption