Learning Outcomes
This article examines the legal principles surrounding the transfer of real property subject to a mortgage or other security device. It focuses on the default rules allowing transfer, the essential distinction between taking property "subject to" a mortgage versus "assuming" the mortgage obligation, and the operation and enforceability of "due-on-sale" clauses. After reviewing this material, you will be equipped to analyze MBE questions involving the rights and liabilities of mortgagors, mortgagees, and transferees when mortgaged property is sold or otherwise transferred.
MBE Syllabus
For the MBE, you are required to understand how mortgages and other security devices affect the transferability of real property. This includes knowing the consequences for the original mortgagor and the transferee, and the specific rules governing due-on-sale clauses. You should be prepared to:
- 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.
- Define and explain the purpose of a due-on-sale (or acceleration) clause.
- Apply the rules regarding the enforceability of due-on-sale clauses, including the impact of federal preemption (Garn-St Germain Act) and its exceptions.
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.
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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?
- The buyer only.
- The seller only.
- Both the buyer and the seller.
- Neither the buyer nor the seller; Lender's only recourse is foreclosure.
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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:
- Purchaser only.
- Homeowner only.
- Either Homeowner or Purchaser or both.
- Neither Homeowner nor Purchaser personally; Bank must foreclose.
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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?
- A transfer where a joint tenant dies, passing title to the surviving joint tenant.
- A transfer to the borrower's spouse resulting from a divorce decree.
- A transfer of the property into an inter vivos trust where the borrower remains a beneficiary.
- 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. However, the mortgage remains attached to the property, meaning the mortgagee (lender) retains its security interest even after the transfer.
The critical issues upon transfer involve (1) who is personally liable for the mortgage debt after the transfer, and (2) whether the lender can demand immediate payment of the entire loan balance upon transfer, typically through a "due-on-sale" clause. The transferee's liability depends on whether they took the property "subject to" the mortgage or "assumed" the mortgage. The enforceability of due-on-sale clauses is largely governed by federal law.
Mortgagor's Right to Transfer
The fundamental principle is that a mortgagor can freely transfer title to mortgaged property. The mortgage represents a security interest, not a restraint on alienation. Upon transfer, the property remains subject to the mortgage unless the mortgagee is paid off from the sale proceeds or otherwise agrees to release the lien.
Liability of Parties After Transfer
When property subject to a mortgage is transferred, the personal liability for the mortgage debt depends on the nature of the transfer agreement between the mortgagor (seller/transferor) and the transferee (buyer/recipient).
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. The property is still security for the loan, so if the loan is not paid (by either the original mortgagor or the transferee), the lender can foreclose on the property. However, if foreclosure produces less than the outstanding debt, the lender can only pursue the original mortgagor for a deficiency judgment; the lender cannot sue the transferee personally.
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.
Assuming the Mortgage
If the transferee "assumes" the mortgage, the transferee makes a personal promise to pay the debt. Both the original mortgagor and the assuming transferee are personally liable to the lender. The original mortgagor becomes secondarily liable as a surety. If the loan defaults, the lender can sue either the original mortgagor or the assuming transferee (or both) for the debt. If the lender forecloses and the sale yields less than the debt, the lender can seek a deficiency judgment against both the original mortgagor and the assuming transferee.
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.
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. An assumption must typically be express; if the deed is silent or ambiguous, the transfer is presumed to be "subject to" the mortgage.
Worked Example 1.1
Seller owns a house worth 200,000 mortgage held by Bank. Seller sells the house to Buyer for 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 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.
Due-on-Sale Clauses
Most modern mortgages contain a "due-on-sale" clause (also known as an acceleration clause). This clause 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.
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.
The primary purpose of a due-on-sale clause is to protect the lender from transferring the loan to a less creditworthy buyer and to allow the lender to raise the interest rate (or charge an assumption fee) when the property is sold during a period of rising interest rates.
Enforceability - The Garn-St Germain Act
The enforceability of due-on-sale clauses is governed by the federal Garn-St Germain Depository Institutions Act of 1982. This Act preempts state laws that restrict the enforcement of due-on-sale clauses. The general rule under the Act is that due-on-sale clauses are enforceable for all types of mortgage loans on all types of real property, unless a specific exception applies.
Exceptions Under Garn-St Germain
The Act specifically exempts certain types of transfers (primarily non-substantive changes in ownership or transfers within a family) related to residential real property containing fewer than five dwelling units. For these exempt transfers, a lender may not exercise its due-on-sale clause. Key exceptions include:
- A transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety.
- A transfer to a relative resulting from the death of the borrower.
- A transfer where the spouse or children of the borrower become an owner of the property.
- A transfer resulting from a decree of dissolution of marriage, legal separation agreement, or incidental property settlement agreement, by which the spouse of the borrower becomes an owner of the property.
- A transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property.
- The granting of a leasehold interest of three years or less not containing an option to purchase.
Exam Warning
Remember that the Garn-St Germain Act exceptions apply primarily to residential property. Due-on-sale clauses in mortgages on commercial property are generally fully enforceable upon any transfer, unless the mortgage document itself provides otherwise.
Key Point Checklist
This article has covered the following key knowledge points:
- Mortgagors generally have the right to transfer mortgaged property.
- A mortgage lien remains on the property after transfer unless paid off.
- Liability for the debt depends on whether the transferee took "subject to" or "assumed" the mortgage.
- "Subject to" means the transferee is not personally liable; the original mortgagor remains liable.
- "Assumption" means the transferee becomes personally liable, along with the original mortgagor (who becomes secondarily liable).
- Due-on-sale clauses allow lenders to demand full loan payment upon transfer.
- The Garn-St Germain Act makes due-on-sale clauses generally enforceable, preempting contrary state law.
- Specific exceptions under Garn-St Germain prevent enforcement for certain family-related or non-substantive transfers of residential property.
Key Terms and Concepts
- Subject To Mortgage
- Assumption of Mortgage
- Due-on-Sale Clause
