Mortgages/security devices - Foreclosure

Learning Outcomes

After reading this article, you will be able to explain the foreclosure process for mortgages and security devices, identify the effect of foreclosure on junior and senior interests, and distinguish between equity of redemption and statutory redemption. You will also be able to apply priority rules and analyze deficiency judgments in MBE-style questions.

MBE Syllabus

For MBE, you are required to understand the legal consequences and procedures relating to foreclosure of mortgages and security devices. This includes the rights and obligations of mortgagors and mortgagees, the effect of foreclosure on other interests, and the remedies available after foreclosure.

• Recognize the steps and methods of foreclosure (judicial and nonjudicial).
• Determine the effect of foreclosure on junior and senior interests.
• Apply the rules of priority among multiple mortgages and liens.
• Explain the concepts of equity of redemption and statutory redemption.
• Analyze deficiency judgments and surplus distribution.
• Identify the impact of foreclosure on parties' rights and obligations.

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. If a senior mortgage is foreclosed, what happens to junior interests?
   1. They are wiped out by the foreclosure.
   2. They remain attached to the property.
   3. They become senior interests.
   4. They are converted into personal judgments.
2. Which of the following is true about the equity of redemption?
   1. It allows the mortgagor to redeem the property after the foreclosure sale.
   2. It is only available to junior lienholders.
   3. It allows the mortgagor to redeem before the foreclosure sale by paying the debt in full.
   4. It is a right held by the mortgagee.
3. What is the effect of a foreclosure sale on a senior interest that was not joined in the action?
   1. The senior interest is eliminated.
   2. The senior interest remains unaffected.
   3. The senior interest is reduced to a judgment lien.
   4. The senior interest is converted to a junior interest.
4. If a foreclosure sale yields less than the amount owed on the mortgage, what remedy may the mortgagee seek?
   1. Statutory redemption.
   2. Deficiency judgment.
   3. Surplus distribution.
   4. Merger.

Introduction

Foreclosure is the legal process by which a mortgagee or other security interest holder forces the sale of real property to satisfy an unpaid debt. Understanding foreclosure is essential for the MBE, as it tests your ability to apply priority rules, redemption rights, and the consequences for all parties involved.

Types of Foreclosure

There are two main foreclosure methods:

• Judicial foreclosure: The mortgagee files a lawsuit, obtains a court order, and the property is sold under court supervision.
• Nonjudicial foreclosure: Permitted in some states for deeds of trust or mortgages with a power-of-sale clause, allowing the property to be sold without court involvement.

Key Term: Foreclosure
The process by which a mortgagee or other security interest holder forces the sale of real property to satisfy a secured debt.

Effect of Foreclosure on Interests

Foreclosure affects the rights of all parties with interests in the property. The outcome depends on the priority of those interests.

Senior and Junior Interests

• Senior interests: Interests recorded before the foreclosing mortgage. These survive foreclosure; the buyer takes subject to them.
• Junior interests: Interests recorded after the foreclosing mortgage. These are eliminated by foreclosure if they are properly joined in the action.

Key Term: Priority
The order in which multiple mortgages or liens are satisfied from the proceeds of a foreclosure sale, usually determined by the time of recording.

Distribution of Foreclosure Sale Proceeds

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

1. Costs of the sale (court fees, attorney fees).
2. Payment of the foreclosing mortgage (including accrued interest).
3. Payment of junior interests in order of priority.
4. Any surplus is paid to the mortgagor (borrower).

If the sale proceeds are insufficient to pay the foreclosing mortgage in full, the mortgagee may seek a deficiency judgment against the mortgagor for the remaining balance.

Key Term: Deficiency Judgment
A court order allowing a mortgagee to recover the unpaid balance of the debt after a foreclosure sale if the sale proceeds are insufficient.

Redemption Rights

There are two main types of redemption rights:

• Equity of redemption: The mortgagor's right to redeem the property by paying the full debt and accrued interest at any time before the foreclosure sale.
• Statutory redemption: In some states, the mortgagor (and sometimes junior lienholders) may redeem the property by paying the foreclosure sale price within a statutory period after the sale.

Key Term: Equity of Redemption
The right of the mortgagor to redeem the property by paying the full debt before the foreclosure sale.

Key Term: Statutory Redemption
The right, provided by statute in some states, to redeem the property after the foreclosure sale by paying the sale price within a specified period.

Effect of Foreclosure on Parties

• Mortgagor: Loses title and right to possession after foreclosure, unless statutory redemption applies.
• Mortgagee (foreclosing): Receives payment from sale proceeds; may seek a deficiency judgment if proceeds are insufficient.
• Junior interests: Wiped out if joined in the foreclosure; holders may seek payment from surplus, if any.
• Senior interests: Remain attached to the property; buyer at foreclosure sale takes subject to these.

Worked Example 1.1

A bank holds a first mortgage on Blackacre. A second lender holds a second mortgage. The owner defaults on both. The second lender forecloses, but the bank is not joined in the action. What is the effect on the bank's mortgage?

Answer: The bank's senior mortgage is unaffected by the foreclosure. The buyer at the foreclosure sale takes subject to the bank's mortgage and must pay or risk another foreclosure.

Worked Example 1.2

A mortgagor defaults, and the property is sold at foreclosure for $80,000. The outstanding mortgage debt is$100,000. What can the mortgagee do?

Answer: The mortgagee may seek a deficiency judgment against the mortgagor for the $20,000 shortfall, unless state law prohibits deficiency judgments.

Exam Warning

On the MBE, be careful to distinguish between equity of redemption (before the sale) and statutory redemption (after the sale). Not all states provide statutory redemption, and the time limits differ.

Revision Tip

Always determine the priority of interests before analyzing the effect of foreclosure. Remember: foreclosure wipes out junior interests, but not senior ones.

Key Point Checklist

This article has covered the following key knowledge points:

• Foreclosure is the process by which a mortgagee forces the sale of property to satisfy a debt.
• Judicial and nonjudicial foreclosure are the two main methods.
• Foreclosure wipes out junior interests but leaves senior interests intact.
• Priority of interests is usually determined by the order of recording.
• Proceeds from the sale are distributed first to costs, then to the foreclosing mortgagee, then to junior interests, and any surplus to the mortgagor.
• The mortgagee may seek a deficiency judgment if the sale proceeds are insufficient.
• The mortgagor has an equity of redemption before the sale and may have a statutory right of redemption after the sale in some states.
• The effect of foreclosure on parties depends on their interest's priority and whether they were joined in the action.

Key Terms and Concepts

• Foreclosure
• Priority
• Deficiency Judgment
• Equity of Redemption
• Statutory Redemption