Mortgages/security devices - Payment (including prepayment)

Learning Outcomes

After reading this article, you will be able to identify and explain the rules governing payment of mortgages and security devices, including the borrower's payment obligations, the enforceability and limits of prepayment, and the operation of acceleration clauses. You will also be able to apply these principles to MBE-style questions and spot common pitfalls relating to payment and prepayment in mortgage law.

MBE Syllabus

For the MBE, you are required to understand the legal framework for payment and prepayment of mortgages and security devices. This includes:

  • The borrower's obligation to pay the mortgage debt and the consequences of default.
  • The enforceability of prepayment by the borrower and the effect of prepayment penalties.
  • The operation and effect of acceleration clauses.
  • The impact of payment and prepayment on foreclosure and the lender's remedies.
  • The rights and limits of the mortgagor and mortgagee regarding payment, prepayment, and discharge.

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. Which of the following is generally true about a borrower's right to prepay a mortgage?
    1. The borrower may prepay at any time without restriction.
    2. The borrower may prepay only if the mortgage or note expressly allows it.
    3. Prepayment is always prohibited by law.
    4. Prepayment automatically discharges all liens on the property.
  2. What is the primary legal effect of an acceleration clause in a mortgage note?
    1. It allows the lender to demand immediate payment of the entire debt upon default.
    2. It prohibits the borrower from making any prepayments.
    3. It requires the lender to accept partial payments after default.
    4. It automatically releases the mortgage upon partial payment.
  3. If a mortgage contains a prepayment penalty clause, which of the following is most accurate?
    1. The penalty is always unenforceable.
    2. The penalty is enforceable if it is reasonable and not contrary to law.
    3. The penalty is enforceable only if the borrower is in default.
    4. The penalty applies only to commercial mortgages.

Introduction

A mortgage or security device secures repayment of a loan with an interest in real property. The borrower's duty to pay, the right to prepay, and the consequences of default are central to mortgage law and frequently tested on the MBE. This article explains the rules governing payment and prepayment, including the enforceability of prepayment, the effect of acceleration clauses, and the limits on penalties.

Payment Obligations Under a Mortgage

The borrower (mortgagor) is obligated to pay the principal and interest according to the terms of the note and mortgage. Failure to pay as agreed is a default, which may trigger the lender's remedies, including foreclosure.

Key Term: Mortgage A security interest in real property given to secure repayment of a debt, typically evidenced by a promissory note.

Prepayment of Mortgages

Borrowers sometimes wish to pay off their mortgage early. The right to prepay is not automatic. At common law, a borrower could not prepay unless the mortgage or note expressly allowed it. Modern practice varies, but unless the loan documents grant a right to prepay, the lender may refuse early payment.

Key Term: Prepayment The act of paying off all or part of a mortgage loan before it is due under the terms of the note.

Prepayment Penalties

Many mortgages, especially commercial ones, include a prepayment penalty clause. This clause requires the borrower to pay an additional fee if the loan is paid off early. Courts generally enforce prepayment penalties if they are reasonable and not contrary to statute or public policy. Excessive or punitive penalties may be struck down.

Key Term: Prepayment Penalty A contractual fee charged by the lender if the borrower pays off the mortgage before maturity, intended to compensate for lost interest.

Acceleration Clauses

Most mortgages contain an acceleration clause. This clause allows the lender to declare the entire loan balance due immediately upon the borrower's default (such as missing a payment or violating another term).

Key Term: Acceleration Clause A provision in a loan agreement that permits the lender to demand immediate payment of the entire outstanding balance upon the occurrence of a specified event, usually default.

Effect of Prepayment After Acceleration

If the lender accelerates the debt, the borrower may redeem the property by paying the full accelerated amount (plus any lawful penalties and interest) before foreclosure. However, if the note prohibits prepayment after acceleration, the borrower may be unable to avoid foreclosure by tendering only the missed payments.

Discharge of the Mortgage

Full payment of the debt (including any lawful prepayment penalties and interest) discharges the mortgage, and the lender must release its security interest. If the borrower tenders payment and the lender refuses to accept it, the borrower may have a defense to foreclosure.

Worked Example 1.1

A homeowner takes out a 15-year mortgage loan. The note is silent on prepayment. Five years later, the homeowner wants to pay off the remaining balance in full. The lender refuses, insisting on continuing to collect monthly payments.

Answer: Unless the note or mortgage expressly allows prepayment, the lender can refuse early payment. The homeowner has no right to prepay unless the loan documents grant it or state law provides otherwise.

Worked Example 1.2

A borrower defaults on a mortgage containing an acceleration clause and a prepayment penalty. The lender accelerates the debt and begins foreclosure. The borrower offers to pay the full amount plus the penalty before the sale.

Answer: The lender must accept full payment (including any reasonable prepayment penalty) and release the mortgage, stopping the foreclosure. However, if the penalty is unreasonably high, a court may refuse to enforce it.

Exam Warning

Prepayment penalties are generally enforceable if reasonable, but excessive penalties may be struck down as an unlawful restraint on alienation or as a penalty rather than liquidated damages. Always check if the penalty is proportionate and not contrary to statute.

Revision Tip

Always check the loan documents for express prepayment terms, penalties, and acceleration clauses. Do not assume prepayment is allowed unless clearly stated.

Key Point Checklist

This article has covered the following key knowledge points:

  • The borrower's obligation to pay the mortgage debt is governed by the note and mortgage terms.
  • Prepayment is not a right unless expressly allowed by the loan documents or required by law.
  • Prepayment penalties are enforceable if reasonable and not contrary to law.
  • Acceleration clauses allow the lender to demand full payment upon default.
  • Full payment (including any lawful penalties) discharges the mortgage and ends the lender's security interest.

Key Terms and Concepts

  • Mortgage
  • Prepayment
  • Prepayment Penalty
  • Acceleration Clause
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