Mortgages/security devices - Future advance mortgages

Learning Outcomes

After reading this article, you will be able to identify what a future advance mortgage is, explain how priority is determined between future advances and intervening interests, distinguish between obligatory and optional advances, and apply these principles to MBE-style questions. You will also understand the impact of notice and recording on future advances, and recognize common pitfalls tested on the MBE.

MBE Syllabus

For the MBE, you are required to understand the rules governing security interests in real property, including future advance mortgages. This article focuses your revision on:

• Recognizing what constitutes a future advance mortgage.
• Determining the priority of future advances versus intervening liens or interests.
• Distinguishing between obligatory and optional advances.
• Applying the rules regarding notice and recording to future advances.
• Understanding the effect of actual and constructive notice on priority.
• Identifying how future advance mortgages are treated in foreclosure.

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 lender makes a loan to a borrower secured by a mortgage that allows for future advances. If the lender makes a second advance after a junior lien is recorded, under what circumstances will the future advance have priority over the junior lien?
2. What is the difference between an obligatory and an optional future advance in the context of mortgage priority?
3. If a lender has notice of an intervening lien before making a future advance, how does this affect the priority of that advance?
4. In a foreclosure, how are future advances treated if they are made after a junior mortgage is recorded?

Introduction

A future advance mortgage is a security device where a lender agrees to make additional loans to a borrower after the initial loan, all secured by the same mortgage. These advances may be made at the time of the original loan or at later dates. The MBE tests your ability to determine when these future advances have priority over other interests, and how notice and the nature of the advance affect this priority.

Key Term: Future Advance Mortgage A mortgage arrangement where the lender agrees to make additional loans to the borrower in the future, all secured by the same mortgage instrument.

Types of Future Advances

Future advances fall into two categories:

• Obligatory Advances: The lender is contractually required to make the additional loan(s) if the borrower requests them and meets the conditions.
• Optional Advances: The lender may, but is not required to, make the additional loan(s).

Key Term: Obligatory Advance A future loan that the lender is contractually bound to make under the terms of the mortgage.

Key Term: Optional Advance A future loan that the lender may choose, but is not required, to make under the mortgage agreement.

Priority of Future Advances

The main exam issue is whether a future advance has priority over a third party’s intervening interest (such as a later mortgage, judgment lien, or other encumbrance). The rules differ depending on whether the advance is obligatory or optional, and whether the lender had notice of the intervening interest.

General Rule

• If the mortgage is properly recorded, future advances made before an intervening interest is recorded will have priority over that interest.
• For advances made after an intervening interest is recorded, priority depends on:
  • Whether the advance was obligatory or optional.
  • Whether the lender had notice (actual or constructive) of the intervening interest.

Obligatory Advances

• Advances the lender is required to make under the original mortgage have priority over intervening interests, even if made after the intervening interest is recorded, as long as the mortgage was recorded first and the lender had no notice requirement in the contract.

Optional Advances

• Advances the lender is not required to make will have priority over intervening interests only if the lender had no notice (actual or constructive) of the intervening interest at the time the advance was made.
• If the lender has notice of the intervening interest, any optional advance made after that notice is subordinate to the intervening interest.

Key Term: Notice (for Future Advances) Actual or constructive knowledge by the lender of an intervening lien or encumbrance at the time a future advance is made.

Recording and Notice

• A properly recorded future advance mortgage gives constructive notice to subsequent purchasers and encumbrancers that future advances may be made.
• However, if the lender has actual notice of an intervening lien before making an optional advance, the advance will be junior to that lien.

Foreclosure and Future Advances

• In foreclosure, the mortgagee may recover all advances that have priority over junior interests.
• Optional advances made after notice of a junior lien are not recoverable from the foreclosure proceeds ahead of the junior lienholder.

Worked Example 1.1

A bank lends $100,000 to a borrower secured by a recorded mortgage that allows for future advances up to$200,000. The mortgage states that the bank may, but is not required to, make additional advances. The borrower later borrows another $50,000 from the bank. After the first loan but before the second, a judgment creditor records a lien against the property. The bank has no knowledge of the lien when it makes the second advance.

Answer: The first advance ($100,000) has priority over the judgment lien. The second advance ($50,000) is optional, but because the bank had no notice of the judgment lien at the time of the advance, it also has priority over the lien.

Worked Example 1.2

Same facts as above, except the bank learns of the judgment lien before making the second $50,000 advance.

Answer: The first advance ($100,000) has priority. The second advance ($50,000) is subordinate to the judgment lien because the bank had notice of the intervening lien before making the optional advance.

Worked Example 1.3

A mortgage secures a construction loan. The lender is contractually obligated to disburse funds as the project reaches certain milestones. After the mortgage is recorded but before all funds are disbursed, a second mortgage is recorded. The lender has no notice of the second mortgage.

Answer: All advances made under the construction loan are obligatory. They have priority over the second mortgage, even if disbursed after the second mortgage is recorded.

Exam Warning

On the MBE, do not assume all future advances have priority. Always check if the advance was obligatory or optional, and whether the lender had notice of any intervening interest before making the advance.

Revision Tip

When analyzing a future advance mortgage question, first identify whether the advance was obligatory or optional, then determine if the lender had notice of any intervening lien at the time of the advance.

Key Point Checklist

This article has covered the following key knowledge points:

• A future advance mortgage secures present and future loans under a single mortgage.
• Obligatory advances have priority over intervening interests, regardless of notice.
• Optional advances have priority only if made without notice of intervening interests.
• Notice can be actual or constructive; a recorded intervening lien gives constructive notice.
• In foreclosure, only advances with priority over junior liens are paid ahead of those liens.

Key Terms and Concepts

• Future Advance Mortgage
• Obligatory Advance
• Optional Advance
• Notice (for Future Advances)