Mortgages/security devices - Restrictions on transfer (inclu...

Learning Outcomes

This article examines mortgage and security‑device transfer restrictions on the MBE, including:

• How and why mortgaged property remains freely transferable by the mortgagor despite the presence of a lien, and how restraints on alienation issues may arise.
• The precise legal difference between taking property “subject to” an existing mortgage and “assuming” the mortgage debt, and how to spot each from deed language in fact patterns.
• How personal liability is allocated among the original mortgagor, a transferee, and the lender under both “subject to” and assumption transfers, including the availability of deficiency judgments.
• How due‑on‑sale and due‑on‑encumbrance (acceleration) clauses operate, when lenders may elect to accelerate, and what remedies they can pursue against the borrower and the land.
• The effect of the Garn–St Germain Act on otherwise applicable state law limits on due‑on‑sale clauses, and the specific statutory exceptions for protected residential transfers.
• How suretyship principles and novation agreements can shift or extinguish the original mortgagor’s personal liability after an assumption, and how loan modifications can discharge a surety.
• How to approach, organize, and resolve typical bar‑exam style questions testing mortgage transfer restrictions, focusing on identifying liability, enforceability of clauses, and the correct party to sue.

MBE Syllabus

For the MBE, you are required to understand how mortgages and other security devices affect the transferability of real property, with a focus on the following syllabus points:

• Identify the default rule that property subject to a mortgage remains freely transferable by the mortgagor.
• Distinguish between a transferee taking title “subject to” an existing mortgage and “assuming” the mortgage debt.
• Analyze the personal liability of the original mortgagor and the transferee under both “subject to” and “assumption” scenarios.
• Explain the original mortgagor’s status as a surety when the transferee assumes the loan, and the possibility of novation.
• Define and explain the purpose and operation of due-on-sale (acceleration) clauses and related due-on-encumbrance clauses.
• Apply the rules regarding the enforceability of due-on-sale clauses, including the impact of federal preemption under the Garn–St Germain Act and its exceptions.
• Evaluate lender remedies (suit on the note, foreclosure, deficiency judgment, acceleration) following a transfer of the mortgaged property.

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 buyer purchases property from a seller, taking title "subject to" an existing mortgage held by Lender. If the buyer defaults on the mortgage payments, which party is personally liable to Lender for the debt?
   1. The buyer only.
   2. The seller only.
   3. Both the buyer and the seller.
   4. Neither the buyer nor the seller; Lender's only recourse is foreclosure.
2. A homeowner obtains a mortgage loan from Bank. The mortgage contains a standard due-on-sale clause. The homeowner later sells the property to Purchaser, who agrees in writing to "assume and pay the existing mortgage loan." If Purchaser defaults, Bank may sue:
   1. Purchaser only.
   2. Homeowner only.
   3. Either Homeowner or Purchaser or both.
   4. Neither Homeowner nor Purchaser personally; Bank must foreclose.
3. Under the Garn-St Germain Depository Institutions Act, which of the following transfers generally allows a lender to enforce a due-on-sale clause in a residential mortgage?
   1. A transfer where a joint tenant dies, passing title to the surviving joint tenant.
   2. A transfer to the borrower's spouse resulting from a divorce decree.
   3. A transfer of the property into an inter vivos trust where the borrower remains a beneficiary.
   4. A sale of the property to an unrelated third party who obtains their own financing.

Introduction

Generally, the owner of real property burdened by a mortgage (the mortgagor) retains the right to transfer that property. The existence of the mortgage does not, by itself, prevent the sale, gift, or devise of the property. A mortgage (or deed of trust) represents a security interest in the land, not an absolute restraint on alienation. Upon transfer, the property remains subject to the mortgage lien unless the mortgagee (lender) is paid off from the sale proceeds or otherwise agrees to release the lien.

The mortgage loan involves two separate but related documents:

• The promissory note, which imposes personal liability to repay the loan amount.
• The mortgage or deed of trust, which gives the lender a security interest in the real property to secure repayment of the note.

When the mortgagor transfers the property, the lien normally “follows” the land. The critical issues become:

• Who, if anyone, is personally liable on the note after the transfer?
• Can the lender demand immediate payment of the entire loan balance upon transfer, typically through a due-on-sale (acceleration) clause?

These issues turn on whether the transferee took the property “subject to” the mortgage or “assumed” it, and on the presence and enforceability of any due‑on‑sale or similar clause.

Key Term: Subject To Mortgage
An arrangement where a transferee takes title to mortgaged property but does not personally undertake the obligation to pay the existing mortgage debt. The original mortgagor remains solely personally liable, though the property remains subject to foreclosure.

Key Term: Assumption of Mortgage
An arrangement where a transferee takes title to mortgaged property and personally agrees to pay the existing mortgage debt. Both the transferee and the original mortgagor are personally liable to the lender.

Key Term: Due-on-Sale Clause
A provision in a mortgage instrument that permits the lender to accelerate the maturity date of the loan (i.e., demand full payment) if the borrower sells or otherwise transfers an interest in the property without the lender's prior consent.

Key Term: Acceleration Clause
A mortgage term giving the lender the option to declare the entire loan balance immediately due upon the occurrence of a specified event, such as default in payment or an unauthorized transfer.

Key Term: Garn-St Germain Act
The Garn–St Germain Depository Institutions Act of 1982, a federal statute that broadly authorizes institutional lenders to enforce due‑on‑sale and due‑on‑encumbrance clauses, preempting contrary state law, subject to certain statutory exceptions for specified residential transfers.

Key Term: Due-on-Encumbrance Clause
A clause allowing the lender to accelerate the loan if the mortgagor further encumbers the property—such as by granting a junior mortgage or deed of trust—without the lender’s consent.

Key Term: Novation
A new agreement among the lender, the original borrower, and a transferee that substitutes the transferee as the borrower and releases the original borrower from personal liability on the note.

Key Term: Suretyship
The relationship in which one party (the surety) is secondarily liable for another’s debt. In mortgage law, an original mortgagor whose transferee has assumed the loan is treated as a surety for that debt.

The enforceability of due-on-sale and related clauses is largely governed by federal law (Garn–St Germain), while the allocation of personal liability between mortgagor and transferee is governed by state property and contract principles that are relatively uniform for MBE purposes.

Mortgagor's Right to Transfer

The fundamental principle is that a mortgagor can freely transfer title to mortgaged property. A mortgage creates a security interest; it does not, by itself, bar alienation of the fee.

• A mortgagor may sell, gift, or devise the property at any time.
• Unless the mortgage is fully paid and released at closing, the lien remains on the property, and the transferee takes subject to that lien.
• The lender’s rights against the land (foreclosure) do not depend on who owns the property at a given time; they depend on the existence of a valid, recorded security interest and default on the obligation.

At common law, absolute disabling restraints on the alienation of a fee simple are void. By contrast, mortgage provisions such as due-on-sale and due-on-encumbrance clauses are generally upheld as reasonable, partial restraints in a commercial context: they do not forbid transfer, but instead give the lender additional remedies (acceleration) if the transfer occurs without consent. Modern federal law strongly reinforces the enforceability of these clauses for institutional lenders.

Exam-wise, assume:

• Absent an express due‑on‑sale or similar clause, a mortgagor may transfer without the lender’s consent and the lender may not accelerate solely because of the transfer.
• If a valid due‑on‑sale clause exists and is not subject to a statutory exception, the lender generally may elect to accelerate upon an unapproved transfer.

Liability of Parties After Transfer

When property subject to a mortgage is transferred, personal liability for the mortgage debt depends on the agreement between the mortgagor (seller/transferor) and the transferee (buyer/recipient), and, in some situations, on any subsequent agreement with the lender.

Key ideas:

• The note creates personal liability; the mortgage creates in rem liability (against the property).
• Transfer of the property does not, by itself, change who is personally liable on the note.
• Personal liability changes only if the transferee assumes the debt and/or the lender later agrees to a novation releasing the original mortgagor.

Taking "Subject To" the Mortgage

If the transferee takes title “subject to” the mortgage, the transferee does not personally promise to pay the debt. The original mortgagor remains personally liable on the promissory note.

Consequences:

• The property remains security for the loan. If payments are not made (by either the mortgagor or the transferee), the lender may foreclose.
• If the foreclosure sale produces less than the outstanding debt, the lender may seek a deficiency judgment only against the original mortgagor, subject to any state anti-deficiency rules.
• The lender has no personal claim against the transferee, because the transferee never promised the lender to pay the debt.

As between seller and buyer, the parties’ contract may shift economic responsibility. For example, the purchase price may reflect that the buyer will “take subject to” the mortgage and make payments to avoid foreclosure. But unless the buyer expressly assumes the loan, the lender cannot enforce that arrangement directly against the buyer.

Assuming the Mortgage

If the transferee “assumes” the mortgage, the transferee makes a personal promise to pay the debt according to its terms. This is usually evidenced by language in the deed (“assumes and agrees to pay”) or a separate assumption agreement.

Consequences:

• The assuming transferee becomes personally liable to the lender for the loan.
• The original mortgagor remains liable on the note unless released through a novation.
• The original mortgagor now occupies the position of a surety: secondarily liable, with a right to reimbursement from the transferee if the original mortgagor has to pay.

The lender may:

• Sue the assuming transferee personally on the note.
• Sue the original mortgagor personally on the note.
• Foreclose on the property and, if there is a deficiency, seek a deficiency judgment against either or both (although the lender can only collect the debt once).

As between seller and buyer, if the seller is forced to pay the lender, the seller can seek indemnity (reimbursement) from the assuming buyer and, in many jurisdictions, may be equitably subrogated to the lender’s mortgage rights against the property.

Suretyship and Modifications

Because an original mortgagor whose loan has been assumed is treated as a surety, suretyship principles may apply:

• If the lender, without the original mortgagor’s consent, materially modifies the loan in a way that increases the surety’s risk (e.g., increases the interest rate, extends the time in a way that increases total interest due), the surety may be discharged from liability to the extent of the increased risk.
• If the lender releases the assuming transferee from liability without the surety’s consent, the surety may also be discharged, at least to the extent of the impairment.

These doctrines occasionally appear on the MBE in more advanced mortgage questions; the key is recognizing the original mortgagor’s role as a surety once the loan has been assumed.

Novation and Release of the Original Mortgagor

The original mortgagor is liable on the note unless the lender explicitly releases the mortgagor. That release typically takes the form of a novation.

A novation requires agreement among all three parties—lender, original mortgagor, and transferee—and substitutes the transferee as the sole obligor on the note. After a valid novation:

• The original mortgagor is no longer personally liable on the debt.
• The transferee is solely personally liable (in addition to the property remaining security).

Absent clear facts showing a novation, treat the original mortgagor as still liable, even if the transferee has assumed the loan.

Distinguishing "Subject To" from "Assumption"

Whether a transfer is “subject to” or involves an “assumption” depends on the language in the deed or a separate agreement. Important points:

• An assumption must typically be express and in writing.
• If the deed is silent or ambiguous about the transferee’s promise, the majority rule (and the rule to assume on the MBE) is that the transferee takes subject to the mortgage, not by assumption.
• Because a promise to answer for another’s debt ordinarily falls within the statute of frauds, an oral promise to assume the mortgage is often unenforceable.

Lender’s Rights Against an Assuming Transferee

If the transferee expressly assumes the mortgage:

• The lender can usually enforce that promise directly as a third‑party beneficiary of the assumption agreement, even if the lender was not a party to the original sale contract.
• Once the lender has notice of the assumption, it may sue the transferee directly on the note.

If the transferee did not assume:

• The lender’s remedies are limited to foreclosure and any personal action against the original mortgagor.
• Even if the buyer is making payments directly to the lender, that alone does not create personal liability absent an assumption agreement.

Worked Example 1.1

Seller owns a house worth $300,000, subject to a $200,000 mortgage held by Bank. Seller sells the house to Buyer for $300,000. Buyer pays Seller $100,000 cash, and the deed states that Buyer takes title "subject to the existing mortgage." Buyer makes payments for a year but then defaults. The house is sold at foreclosure for $180,000, leaving a $20,000 deficiency on the loan balance. Can Bank obtain a deficiency judgment against Buyer? Can Bank obtain one against Seller?

Answer:
Bank cannot obtain a deficiency judgment against Buyer. Buyer took title "subject to" the mortgage and did not personally promise to pay the debt. Bank can obtain a deficiency judgment against Seller. Seller remained personally liable on the original promissory note.

Worked Example 1.2

Same facts as Example 1.1, but the deed states that Buyer "hereby assumes and agrees to pay the existing mortgage held by Bank according to its terms." Buyer defaults, and the foreclosure sale leaves a $20,000 deficiency. Who can Bank pursue for the deficiency?

Answer:
Bank can pursue both Buyer and Seller for the deficiency. Buyer is personally liable because she expressly assumed the mortgage debt. Seller remains secondarily liable as the original borrower/surety. Bank can collect the $20,000 deficiency from either party (but only once). If Seller pays, Seller can seek reimbursement from Buyer.

Worked Example 1.3

A corporate officer borrows money from her corporation at a favorable interest rate and gives the corporation a properly recorded mortgage on her land. The note contains a due-on-sale clause giving the corporation, at its option, the right to demand full payment if she sells the land without written consent. After three years of timely payments, she sells the land to Buyer without obtaining consent. The deed provides that Buyer takes the land “subject to” the mortgage. Neither the officer nor Buyer makes further payments. The corporation sues Buyer for the full outstanding balance on the note, relying on the due-on-sale clause. Is Buyer personally liable?

Answer:
No. Buyer purchased the land subject to the mortgage and made no personal promise to pay the debt. The due‑on‑sale clause gives the lender a right to accelerate the debt against the borrower and foreclose against the property upon transfer; it does not create personal liability in a transferee who has not assumed the mortgage. The corporation’s remedies are limited to acceleration, foreclosure, and any personal action against the original borrower.

Due-on-Sale Clauses

Most modern institutional mortgages contain a due-on-sale clause (also known as a due‑on‑transfer clause), which is a specific type of acceleration clause. This provision gives the lender the option to demand immediate payment of the entire outstanding loan balance if the mortgagor transfers any interest in the property without the lender's consent.

The primary purposes of a due-on-sale clause are:

• To prevent the loan from being effectively “assigned” to a new borrower whose credit the lender has not evaluated.
• To allow the lender to renegotiate the interest rate or other terms if the property is sold in a rising interest-rate environment.
• To preserve the lender’s collateral position by maintaining control over who owns and manages the property.

Due-on-sale clauses do not absolutely forbid transfer. Instead, they:

• Allow the borrower to transfer, but
• Give the lender a contractual right to accelerate and foreclose if the transfer occurs without consent.

In practice, lenders often agree to waive or conditionally waive the due‑on‑sale clause—for example, by permitting an assumption on new terms, charging an assumption fee, or adjusting the interest rate—especially when credit conditions are favorable.

Operation of Due-on-Sale and Due-on-Encumbrance Clauses

When a due-on-sale clause exists:

• A transfer without required consent triggers the lender’s option to accelerate.
• Acceleration is not automatic; the lender must elect to accelerate (typically by giving notice).
• If the lender accelerates and the borrower or transferee fails to pay, the lender may foreclose.

A due-on-encumbrance clause works similarly but is triggered when the borrower creates a junior lien (e.g., a second mortgage or home‑equity loan) without consent. Like due‑on‑sale clauses, these clauses are generally enforceable for institutional lenders under federal law.

Enforceability – The Garn-St Germain Act

Historically, some states limited or prohibited enforcement of due-on-sale clauses as unreasonable restraints on alienation. The Garn-St Germain Depository Institutions Act of 1982 largely eliminated this variability by preempting inconsistent state law.

Under Garn-St Germain:

• Institutional lenders (e.g., banks, savings associations) may generally enforce due‑on‑sale and due‑on‑encumbrance clauses in any real estate loan.
• State laws that would otherwise restrict enforcement are preempted.
• Certain specified categories of transfers involving residential real property containing fewer than five dwelling units are exempt; for those transfers, a lender may not enforce a due-on-sale clause.

For MBE purposes, assume that, absent a statutory exception, due‑on‑sale clauses in both residential and commercial mortgages held by institutional lenders are fully enforceable upon any transfer in violation of the clause.

Exceptions Under Garn-St Germain

The Act specifically exempts certain types of transfers, primarily non‑substantive ownership changes or transfers within a family, involving residential real property with fewer than five dwelling units (e.g., single‑family homes, duplexes, small apartment buildings, condos, and co‑ops).

For these exempt transfers, a lender may not exercise its due‑on‑sale clause. Key exceptions include:

• Devise, descent, or operation of law on death of a joint tenant or tenant by the entirety.
  Example: A joint tenant dies and the surviving joint tenant becomes sole owner. Lender may not accelerate solely because of this transfer.

• Transfer to a relative resulting from the borrower’s death.
  Example: Borrower dies and property passes to her child under a will or by intestacy. Lender must allow the heir to take title without acceleration (though it may require continued payments).

• Transfer where the spouse or children of the borrower become an owner of the property.
  Example: Borrower adds her spouse to the title as a co‑owner. The lender may not invoke the due‑on‑sale clause.

• Transfers incident to divorce or legal separation.
  A transfer resulting from a decree of dissolution, legal separation agreement, or property settlement by which the spouse of the borrower becomes an owner is protected.

• Transfer into an inter vivos trust in which:

  • The borrower is and remains a beneficiary, and
  • The transfer does not change the borrower’s occupancy rights.
    Common example: Borrower places her home into a revocable living trust for estate planning while continuing to live there. Lender may not accelerate.

• Granting of a leasehold interest of three years or less that does not contain an option to purchase.
  Ordinary short‑term residential leases do not trigger the clause. Longer leases or leases coupled with options to purchase can.

Transfers that fall outside these protected categories—such as an outright sale to an unrelated buyer or a long‑term lease with an option to purchase—generally allow the lender to enforce a due-on-sale clause.

Worked Example 1.4

Homeowner borrows from Bank, giving a mortgage on her single‑family residence. The mortgage contains a due-on-sale clause. Homeowner later executes a deed conveying the property to “Homeowner and Spouse as joint tenants,” and properly records it. Homeowner continues to live in the property and make payments. Bank learns of the transfer and demands full payment of the loan, threatening foreclosure if not paid. May Bank enforce the due-on-sale clause?

Answer:
No. The transfer added the borrower’s spouse as an owner of the residential property. Under Garn–St Germain, a transfer in which the spouse or children of the borrower become an owner of the property is an exempt transaction, and the lender may not enforce the due‑on‑sale clause solely on that basis, so long as the borrower continues to meet loan obligations.

Worked Example 1.5

Borrower owns a single‑family home subject to a mortgage with a due‑on‑sale clause held by Bank. Borrower conveys the property by deed to a revocable living trust of which Borrower is the grantor and sole beneficiary. Borrower continues to live in the home and make payments. Bank discovers the transfer and accelerates the loan. Is acceleration proper?

Answer:
No. Garn–St Germain protects transfers of residential property into an inter vivos trust in which the borrower is and remains a beneficiary and where the transfer does not relate to a transfer of occupancy rights. Here, Borrower remains the beneficiary and occupant. Bank may not enforce the due‑on‑sale clause solely because of this trust transfer.

Worked Example 1.6

Borrower owns a four‑unit residential building, encumbered by a mortgage held by Lender containing a due‑on‑sale clause. Borrower signs a 10‑year lease of the entire building to Tenant, with an option for Tenant to purchase the property at any time during the lease term. Borrower does not obtain Lender’s consent. Lender seeks to accelerate the loan based on the due‑on‑sale clause. Is Lender entitled to accelerate?

Answer:
Yes. Garn–St Germain protects only leases of three years or less that do not contain an option to purchase. A 10‑year lease with an option to purchase is not exempt. Lender may enforce the due‑on‑sale clause and accelerate the loan if it chooses.

Due-on-Sale Clauses and Assumptions

In many transactions:

• The property is sold, and
• The lender agrees to waive strict enforcement of the due‑on‑sale clause if the buyer assumes the loan on terms acceptable to the lender.

In that case:

• The buyer becomes personally liable (assumption).
• The original mortgagor remains liable unless released via novation.
• The lender may adjust the interest rate, charge an assumption fee, or impose other conditions as part of allowing the assumption.

Exam questions may test whether the lender can enforce the due‑on‑sale clause against a transferee who has not assumed the loan. The answer is:

• The clause authorizes acceleration against the borrower and foreclosure against the property; it does not itself create personal liability against a non‑assuming transferee.

Exam Warning

Remember that the Garn-St Germain Act exceptions apply primarily to residential property containing fewer than five dwelling units. Due-on-sale clauses in mortgages on commercial property or large multi‑family properties are generally fully enforceable upon any transfer, unless the mortgage document itself restricts enforcement.

Key Point Checklist

This article has covered the following key knowledge points:

• Mortgagors generally have the right to transfer mortgaged property; a mortgage is a security device, not a bar to alienation.
• A mortgage lien remains on the property after transfer unless paid off or released.
• Personal liability on the debt is distinct from the existence of the lien; transfer does not automatically alter who is liable on the note.
• Liability for the debt depends on whether the transferee took “subject to” the mortgage or “assumed” the mortgage.
• “Subject to” means the transferee is not personally liable; the original mortgagor remains personally liable, and the lender’s remedies against the transferee are limited to foreclosure.
• “Assumption” means the transferee becomes personally liable, along with the original mortgagor, who becomes secondarily liable as a surety.
• Because the original mortgagor is a surety after an assumption, certain lender modifications or releases of the assuming transferee can partially or fully discharge the original mortgagor.
• A novation, if agreed by lender, original mortgagor, and transferee, can release the original mortgagor and substitute the transferee as sole obligor.
• Due-on-sale clauses are acceleration clauses that allow lenders to demand full loan payment upon an unapproved transfer, but they do not by themselves create personal liability in a non‑assuming transferee.
• The Garn-St Germain Act makes due-on-sale and due-on-encumbrance clauses generally enforceable for institutional lenders, preempting contrary state law.
• Specific exceptions under Garn-St Germain prevent enforcement of due-on-sale clauses for certain family‑related or non‑substantive transfers of residential property (e.g., transfers to spouses or children, transfers on death, certain trust transfers, short‑term leases without purchase options).
• For leases longer than three years or leases accompanied by options to purchase, and for ordinary sales to third parties, due‑on‑sale clauses remain fully enforceable.

Key Terms and Concepts

• Subject To Mortgage
• Assumption of Mortgage
• Due-on-Sale Clause
• Acceleration Clause
• Garn-St Germain Act
• Due-on-Encumbrance Clause
• Novation
• Suretyship