Mortgages/security devices - Foreclosure

Learning Outcomes

This article explains foreclosure in mortgages and security devices, including:

• How to identify pre-foreclosure rights and duties, such as possession, waste, and the equity of redemption, and how these shape the lender’s options before initiating a sale.
• The steps and methods of foreclosure (judicial and nonjudicial), required notices, sale procedures, and the standards for a commercially reasonable foreclosure on exam fact patterns.
• How foreclosure affects senior and junior interests, including who must be joined, what happens if a party is omitted, and how interests are treated when a senior versus a junior mortgagee forecloses.
• How to apply and prioritize competing liens by using the “first in time, first in right” rule and its major exceptions, including purchase-money mortgages, subordination agreements, modifications, future-advances clauses, and recording-act protection.
• The differences between equity of redemption and statutory redemption, including timing, amounts required to redeem, who may redeem, and the exam-tested limits on “clogging” redemption rights.
• How to analyze deficiency judgments and surplus distribution, determine who can be personally liable on the note, and recognize when anti-deficiency statutes or deeds in lieu alter the usual results.
• The overall impact of foreclosure, deeds in lieu, and redemption on the rights and obligations of mortgagors, mortgagees, junior and senior lienholders, and foreclosure purchasers.

MBE Syllabus

For the MBE, you are required to understand foreclosure of mortgages and security devices, with a focus on the following syllabus points:

• Recognize the steps and methods of foreclosure (judicial and nonjudicial)
• Determine the effect of foreclosure on junior and senior interests, including when interests survive
• Apply the rules of priority among multiple mortgages and liens, including purchase-money priority and recording act issues
• Explain equity of redemption and statutory redemption, and identify when redemption rights may not be waived
• Analyze deficiency judgments, surplus distribution, and the personal liability of mortgagors and assuming grantees
• Identify the impact of foreclosure, deeds in lieu of foreclosure, and redemption on parties’ rights and obligations
• Understand pre-foreclosure rights and duties, including possession, waste, and consumer-protection defenses

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 that are properly joined?
   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 (absent a contrary statute)?
   1. Statutory redemption.
   2. Deficiency judgment.
   3. Surplus distribution.
   4. Merger.
5. An owner has a first mortgage with Bank and a second mortgage with Lender. The owner defaults and gives Bank a deed in lieu of foreclosure, which Bank accepts without reserving the right to foreclose. What is the usual effect on Lender’s second mortgage?
   1. It is wiped out as if Bank had foreclosed.
   2. It becomes senior to Bank’s interest.
   3. It is converted into an unsecured personal judgment.
   4. It continues to encumber the property in Bank’s hands.

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, secured debt. It is one of the most heavily tested mortgage topics on the MBE because it pulls together recording, priority, and remedies concepts and requires careful attention to the timeline of events.

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 after default.

Foreclosure does not occur in a vacuum. Before the sale there are pre-foreclosure rights and duties, and after the sale the rights of mortgagors, mortgagees, junior and senior lienholders, and the purchaser must all be analyzed.

Pre-Foreclosure Rights and Duties

Possession Before Foreclosure

Whether the lender can take possession before foreclosure depends on the jurisdiction’s theory of title:

• Lien theory (majority): The mortgagee holds only a security interest. The mortgagor is the owner until foreclosure, so the lender cannot take possession before foreclosure absent consent or abandonment.
• Title theory (minority): The mortgagee holds legal title and may demand possession at any time, especially after default.
• Intermediate theory (few states): The mortgagor holds title until default; upon default, title shifts to the mortgagee, who can then take possession.

Regardless of theory, all jurisdictions allow a lender to take possession with the mortgagor’s consent or after abandonment.

Waste

The mortgagor must not commit waste that impairs the lender’s security. Destructive or permissive waste that significantly lowers the property’s value—such as tearing out fixtures or letting the roof collapse—can give the mortgagee grounds to seek an injunction or even accelerate foreclosure. Ameliorative changes (improvements) are less of a concern.

Equity of Redemption (Pre-Sale Right)

At common law, the mortgagor has a right to stop foreclosure by paying off the debt.

Key Term: Equity of Redemption
The mortgagor’s common law right to redeem the property and prevent foreclosure by paying the entire debt, plus interest and costs, at any time before the foreclosure sale.

Key points:

• The right exists after default but before the foreclosure sale.
• If the note contains an acceleration clause, the mortgagor usually must pay the full accelerated balance, not just arrears, to redeem.
• There is no partial redemption: the entire mortgage must be satisfied; one joint tenant cannot redeem only “her half.”
• Any attempt in the original mortgage to waive this right is an invalid “clogging” of the equity of redemption.

Key Term: Clogging the Equity of Redemption
Drafting mortgage terms that effectively prevent or waive the mortgagor’s right to redeem before foreclosure; such provisions are not enforced.

Deed in Lieu of Foreclosure

Instead of going through foreclosure, the mortgagor may voluntarily convey the property to the lender.

Key Term: Deed in Lieu of Foreclosure
A conveyance by which the mortgagor transfers title to the lender in exchange for some agreement regarding the outstanding debt, often a release from further liability.

Important exam consequences:

• A deed in lieu does not wipe out junior liens. The lender takes the property subject to existing junior mortgages and liens.
• Junior lienholders can still foreclose against the property in the lender’s hands.
• Because of this, lenders often refuse a deed in lieu when there are substantial junior encumbrances.

Types of Foreclosure

There are two main foreclosure methods:

• Judicial foreclosure:

  • The mortgagee files a lawsuit.
  • The court supervises a public sale of the property.
  • Common in lien-theory states and on exam fact patterns.

• Nonjudicial foreclosure (power-of-sale foreclosure):

  • Permitted in many states where the mortgage or deed of trust includes a power-of-sale clause.
  • The lender (or trustee) conducts a sale without formal court proceedings, but must follow statutory notice and sale procedures.

In both methods, the lender must give proper notice to the mortgagor and to all necessary parties (typically junior lienholders) before the sale.

Effect of Foreclosure on Interests

Foreclosure affects the rights of everyone with an interest in the property. The key questions are:

• Is the interest senior or junior to the mortgage being foreclosed?
• Was the interest holder joined in the foreclosure action?

Key Term: Priority
The order in which multiple mortgages or liens are satisfied from foreclosure proceeds, usually determined by the time of recording, subject to specific priority exceptions.

Key Term: Senior Interest
An interest that has priority over the mortgage being foreclosed, generally because it arose or was recorded earlier or fits a priority exception.

Key Term: Junior Interest
An interest that is subordinate to the mortgage being foreclosed, usually because it was recorded later or does not qualify for a special priority rule.

Senior and Junior Interests

Basic rules:

• Senior interests

  • Acquired or recorded before the foreclosing mortgage (subject to exceptions below).
  • Not destroyed by foreclosure.
  • The foreclosure purchaser takes the property subject to these interests. The senior holder can still foreclose later.

• Junior interests

  • Acquired or recorded after the foreclosing mortgage.
  • Destroyed (“wiped out”) by foreclosure if properly joined in the action.
  • Holders are entitled to payment from sale proceeds (if enough funds remain) but lose their liens on the property.

Because junior lienholders lose their liens, they are necessary parties in a judicial foreclosure. Failure to join a junior lienholder preserves that lien; the purchaser takes subject to it and may face another foreclosure.

Priority Rules and Exceptions

The starting point is “first in time, first in right”: earlier interests are senior. However, several important exceptions regularly appear on the MBE.

Purchase-Money Mortgage Priority

Key Term: Purchase-Money Mortgage
A mortgage given to secure a loan that enables the mortgagor to acquire legal title to the property, whether the lender is a bank or the seller.

A purchase-money mortgage (PMM):

• Has priority over all other interests arising through the purchaser, including prior judgment liens, even if it is recorded later.
• Between two PMMs, a vendor PMM (held by the seller) usually has priority over a third-party PMM; between two third-party PMMs, first to record wins.

Recording Act Exception

If a senior mortgage is not recorded, a later mortgagee who qualifies under the jurisdiction’s recording statute (e.g., as a bona fide purchaser without notice) may take priority over that unrecorded senior interest.

Subordination, Modification, and Future Advances

• Subordination agreements: A senior mortgagee can contractually agree to become junior to another lender.
• Modifications: If a senior mortgage is modified in a way that is more burdensome to a junior lender (for example, the interest rate is increased), the modification is subordinated, but the original terms retain their original priority.
• Future-advances mortgages: Lines of credit secured by a mortgage are generally treated as if all advances were made on the date the mortgage was recorded, giving them priority over later liens (subject to notice issues in some jurisdictions).

Distribution of Foreclosure Sale Proceeds

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

• First, costs of the sale, including court costs, trustee’s fees, and reasonable attorney’s fees.
• Second, payment of the foreclosing mortgage, including accrued interest and allowable costs.
• Third, payment of junior interests that are wiped out by the sale, in order of priority.
• Finally, any surplus is paid to the mortgagor (the borrower).

If the sale proceeds are insufficient to pay the foreclosing mortgage in full, the lender may seek a deficiency judgment.

Key Term: Deficiency Judgment
A personal judgment allowing a mortgagee to recover the unpaid balance of the debt after a foreclosure sale when the sale proceeds do not fully satisfy the secured obligation.

Deficiency rules on the exam:

• The original mortgagor is personally liable on the note unless released or discharged in bankruptcy.
• A subsequent buyer who “assumes” the mortgage is also personally liable; a buyer who takes “subject to” the mortgage is not personally liable.
• Many jurisdictions have anti-deficiency statutes, especially for purchase-money mortgages on residences, limiting or barring deficiencies or capping them at the difference between the debt and the property’s fair market value.

Key Term: Surplus
The remaining proceeds after all foreclosure costs and lienholders are paid; surplus is returned to the mortgagor.

Redemption Rights

There are two distinct types of redemption rights; the MBE regularly tests the difference.

Equity of Redemption (Common Law)

As discussed above, equity of redemption allows the mortgagor to redeem before the foreclosure sale by paying the entire mortgage debt (often accelerated), plus interest and costs. This right:

• Exists in every state as a matter of common law or statute.
• Cannot be waived in the mortgage itself; clauses purporting to waive it are invalid as attempts to clog redemption.

Statutory Redemption (Post-Sale)

Key Term: Statutory Redemption
A statutory right in some states allowing the mortgagor (and sometimes junior lienholders) to redeem the property after the foreclosure sale by paying the foreclosure sale price (or sometimes the debt) within a specified period.

Key features:

• Not all states recognize statutory redemption.
• Where available, the redemption period typically runs from the foreclosure sale for a set time (commonly six months to one year).
• The redeemer usually must pay at least the price paid at the foreclosure sale; some statutes require paying the debt plus costs.
• A valid statutory redemption terminates the purchaser’s title and restores title to the redeeming mortgagor, free of the foreclosed mortgage.

There is still no partial redemption in statutory redemption states: the whole property must be redeemed.

Effect of Foreclosure on Parties

• Mortgagor (Borrower)

  • Loses title and the right to possession after the foreclosure sale, unless statutory redemption is exercised.
  • Remains personally liable for any deficiency judgment, unless released, protected by an anti-deficiency statute, or discharged by agreement (e.g., deed in lieu with a full release).

• Foreclosing Mortgagee (Lender)

  • Receives payment from sale proceeds according to its priority.
  • May bid at the foreclosure sale and often becomes the purchaser.
  • May seek a deficiency judgment if proceeds are insufficient, subject to statutory limits.
  • Must conduct the foreclosure in good faith and in a commercially reasonable manner.

• Junior Interests

  • If properly joined, their liens are wiped out but they may receive payment from the sale proceeds if there is enough after the senior debts are paid.
  • Even if wiped out, they can still pursue the mortgagor personally on the debt (if not barred by bankruptcy or other defenses).

• Senior Interests

  • Unaffected by the foreclosure of a junior mortgage.
  • The purchaser at the junior foreclosure takes subject to any senior interests.

• Purchaser at Foreclosure Sale

  • Takes the property free and clear of junior liens that were properly joined, and subject to senior liens.
  • In states with statutory redemption, takes subject to the mortgagor’s statutory redemption right for the statutory period.

Key Term: Due-on-Sale Clause
A clause in a note or mortgage allowing the lender to accelerate the debt and demand full payment if the mortgagor transfers any interest in the property without the lender’s consent.

Due-on-sale clauses are generally valid and are not considered unreasonable restraints on alienation. They are enforcement tools that can lead to foreclosure if the full balance is not paid after acceleration.

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. A foreclosure by a junior mortgagee does not destroy interests that are senior to the foreclosing lien, whether or not they are joined. The buyer at the foreclosure sale takes subject to the bank's first mortgage and must pay or refinance it or risk a later foreclosure by the bank.

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 takes the $80,000 from the sale proceeds and is still owed $20,000. Absent an applicable anti-deficiency statute or contractual limitation, the mortgagee may seek a deficiency judgment against the mortgagor for the $20,000 shortfall. If a subsequent buyer had assumed the mortgage, the buyer would also be personally liable; a buyer who took “subject to” the mortgage would not.

Worked Example 1.3

A borrower has a purchase-money mortgage to Bank for $200,000 used to buy a home. Earlier, a judgment creditor obtained and recorded a $50,000 judgment lien against the borrower. The borrower defaults on both debts, and Bank forecloses. The property sells for $210,000. How are the proceeds distributed?

Answer:
First, foreclosure costs are paid. Then, Bank’s purchase-money mortgage is paid in full before the judgment lien, even though the judgment lien was recorded earlier. Only after Bank is paid in full will any remaining funds go to the judgment creditor, and any surplus after that goes to the borrower. The PMM has priority over prior judgment liens arising through the purchaser.

Worked Example 1.4

A homeowner gives a first mortgage to Bank and later a second mortgage to Lender. The homeowner defaults only on the second mortgage. Lender forecloses, properly joins Bank, and the property sells at foreclosure. Bank elects not to be paid from the sale and instead insists that its mortgage remain. What does the purchaser receive?

Answer:
The purchaser receives title subject to Bank’s first mortgage (which survives because it is senior) and free of Lender’s second mortgage (which is wiped out by its own foreclosure). The purchaser must continue paying Bank or risk another foreclosure. Proceeds from Lender’s sale are first available to pay Lender, then any junior liens, with any surplus to the homeowner.

Worked Example 1.5

A couple has a first mortgage to Bank and, a year later, grants a second mortgage to Savings & Loan. After defaulting on both, the couple gives Bank a deed in lieu of foreclosure, which Bank accepts without reserving the right to foreclose. What is the effect on Savings & Loan’s second mortgage?

Answer:
The deed in lieu transfers the couple’s equity of redemption to Bank but does not eliminate junior liens. The house remains subject to Savings & Loan’s second mortgage. Savings & Loan may still foreclose its mortgage against Bank’s ownership interest. This is why lenders are cautious about accepting deeds in lieu when significant junior liens exist.

Worked Example 1.6

A mortgagor’s home is sold at a valid foreclosure sale to Buyer. Two months later, the mortgagor receives an inheritance and wants the property back. The jurisdiction provides a six-month statutory redemption period. What must the mortgagor do, and what happens if he succeeds?

Answer:
The mortgagor must exercise statutory redemption by paying the amount required under the statute, typically the foreclosure sale price plus costs, within the six-month period. Successful redemption terminates Buyer’s title and restores title to the mortgagor, free of the foreclosed mortgage. Buyer may be entitled to reimbursement for certain improvements or taxes under state law, but holds no further title.

Exam Warning

On the MBE, pay close attention to:

• Whether the foreclosure is by a senior or junior mortgagee. Only foreclosure by a senior lien can eliminate junior liens (if joined).
• Whether junior lienholders were joined; failure to join a junior interest means it is not wiped out, and the purchaser takes subject to it.
• Distinguishing equity of redemption (pre-sale, pay the debt) from statutory redemption (post-sale, only in some states, typically pay the sale price).
• Whether a subsequent purchaser assumed the mortgage or took subject to it when analyzing deficiency liability.

Revision Tip

When tackling a foreclosure question, work in this order:

• Draw a quick timeline and list all interests with their recording dates.
• Classify each as senior or junior to the foreclosing mortgage and apply any priority exceptions (e.g., purchase-money mortgage).
• Determine which interests are wiped out and which ones survive, and then allocate sale proceeds in priority order and analyze any deficiency.

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 secured debt after default.
• Judicial foreclosure involves a court-supervised sale; nonjudicial foreclosure uses a power-of-sale clause subject to statutory procedures.
• Before foreclosure, the lender’s right to possession depends on whether the jurisdiction follows lien, title, or intermediate title theory, and the mortgagor must avoid waste.
• The mortgagor has an equity of redemption before the sale and, in some states, a statutory right of redemption after the sale; these rights cannot be clogged by waiving them in the mortgage.
• Priority of interests is usually determined by the order of recording, but purchase-money mortgages and recording act rules can override chronology.
• Senior interests generally survive foreclosure, while junior interests are wiped out if properly joined; failure to join a junior lien preserves it against the purchaser.
• Proceeds from the sale are distributed first to costs, then to the foreclosing mortgagee, then to junior interests in order of priority, and any surplus to the mortgagor.
• If sale proceeds are insufficient, the mortgagee may seek a deficiency judgment against the mortgagor (and an assuming grantee), subject to anti-deficiency statutes.
• A deed in lieu of foreclosure transfers the mortgagor’s equity of redemption to the lender but does not eliminate junior liens, which remain attached to the property.
• The purchaser at foreclosure takes free of junior liens but subject to senior liens and any statutory redemption rights that exist.

Key Terms and Concepts

• Foreclosure
• Priority
• Senior Interest
• Junior Interest
• Purchase-Money Mortgage
• Equity of Redemption
• Clogging the Equity of Redemption
• Statutory Redemption
• Deed in Lieu of Foreclosure
• Due-on-Sale Clause
• Deficiency Judgment
• Surplus