Mortgages/security devices - Rights and duties prior to foreclosure

Learning Outcomes

After reading this article, you will be able to identify and explain the rights and duties of mortgagors and mortgagees before foreclosure. You will understand the legal consequences of possession, the doctrine of waste, the concept of equity of redemption, and the limits on contractual restrictions. You will be able to apply these principles to MBE-style questions.

MBE Syllabus

For the MBE, you are required to understand the legal relationship between mortgagor and mortgagee before foreclosure. This includes:

• The right to possession of the mortgaged property prior to foreclosure under different state theories (lien, title, intermediate).
• The mortgagor’s duty not to commit waste and the mortgagee’s remedies.
• The concept of equity of redemption and the prohibition on clogging this right.
• The effect of abandonment, consent, and receiverships.
• The allocation of rents and profits before foreclosure.
• The consequences of mortgagee in possession, including liability and accounting duties.

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. In a lien theory state, who has the right to possess the mortgaged property before foreclosure?
   1. The mortgagee
   2. The mortgagor
   3. The court
   4. The local government
2. Which of the following is true regarding the mortgagor’s right of redemption?
   1. It can be waived in the mortgage contract
   2. It is lost if the mortgagor abandons the property
   3. It exists until the foreclosure sale is complete
   4. It is available only in title theory states
3. What is the effect if a mortgagor commits voluntary waste before foreclosure?
   1. The mortgagee may sue for damages or seek an injunction
   2. The mortgage is automatically extinguished
   3. The mortgagee must foreclose immediately
   4. The mortgagor’s debt is discharged
4. Which of the following best describes “clogging the equity of redemption”?
   1. The mortgagor’s right to possession is limited
   2. The mortgagee is allowed to take possession before default
   3. The mortgagor’s right to redeem is contractually restricted or waived
   4. The mortgagee is required to accept partial payment

Introduction

Before foreclosure, both mortgagor (borrower) and mortgagee (lender) have important rights and duties regarding the mortgaged property. The legal framework varies by state, but certain principles are tested on the MBE. This article explains who may possess the property, the obligations to avoid waste, the right to redeem, and the consequences of mortgagee possession before foreclosure.

Theories of Title and Possession

States follow three main theories regarding title and possession before foreclosure:

• Lien Theory: The mortgage is a security interest only. The mortgagor retains both legal and equitable title and the right to possession until foreclosure.
• Title Theory: The mortgage transfers legal title to the mortgagee, who may take possession at any time, even before default.
• Intermediate Theory: The mortgagor keeps title and possession until default; after default, the mortgagee may take possession.

Key Term: Lien Theory
The majority rule where the mortgagee holds only a security interest, and the mortgagor retains title and possession until foreclosure.

Key Term: Title Theory
A minority rule where the mortgagee holds legal title and may take possession at any time before foreclosure.

Key Term: Intermediate Theory
A hybrid rule where the mortgagee may take possession only after default, but before foreclosure.

Rights to Possession

In most states (lien theory), the mortgagor remains in possession and may use, lease, or sell the property, subject to the mortgage. The mortgagee cannot take possession before foreclosure unless the mortgagor abandons the property or consents.

If the mortgagee does take possession (as allowed in some states), they become a "mortgagee in possession" and assume duties to manage the property prudently, collect rents, pay taxes, and avoid waste.

Key Term: Mortgagee in Possession
A mortgagee who lawfully takes possession of the mortgaged property before foreclosure and assumes duties to manage and account for the property.

Duties of the Mortgagor: Waste

The mortgagor must not commit waste that impairs the mortgagee’s security. Waste includes:

• Voluntary waste: Deliberate destruction or removal of property value.
• Permissive waste: Failure to maintain the property, pay taxes, or prevent deterioration.
• Ameliorative waste: Improvements that increase value are generally permitted unless they impair the mortgagee’s security.

If the mortgagor commits waste, the mortgagee may sue for damages, seek an injunction, or in some cases, accelerate the debt.

Key Term: Waste
Any act or omission by the mortgagor that reduces the value of the mortgaged property and impairs the mortgagee’s security.

Equity of Redemption

The mortgagor has the right to redeem the property by paying the full debt and interest at any time before the foreclosure sale. This is called the equity of redemption.

Any attempt to waive or restrict this right in the mortgage contract is void as "clogging the equity of redemption." The mortgagor cannot be forced to give up the right to redeem as a condition of the mortgage.

Key Term: Equity of Redemption
The mortgagor’s right to pay off the mortgage in full and reclaim the property at any time before the foreclosure sale.

Key Term: Clogging the Equity of Redemption
Any contractual provision or device that restricts or waives the mortgagor’s right to redeem before foreclosure.

Mortgagee in Possession: Duties and Liabilities

If the mortgagee takes possession before foreclosure (by consent, abandonment, or under title/intermediate theory), they must:

• Manage the property as a prudent owner.
• Collect rents and profits and apply them to the mortgage debt.
• Pay taxes and necessary expenses.
• Avoid waste and make reasonable repairs.

The mortgagee in possession is liable for losses caused by mismanagement and must account for all income and expenses.

Receiverships

If the mortgagor is in default and the property is at risk of waste or loss, the mortgagee may ask the court to appoint a receiver to manage the property and collect rents before foreclosure. This is common for income-producing properties.

Key Term: Receiver
A court-appointed manager who takes control of mortgaged property to preserve its value and collect income before foreclosure.

Rents and Profits

Unless otherwise agreed, the mortgagor is entitled to rents and profits until foreclosure. If the mortgagee takes possession or a receiver is appointed, rents and profits are applied to the mortgage debt.

Abandonment and Consent

If the mortgagor abandons the property or consents, the mortgagee may take possession and manage the property. The mortgagee must still account for rents and avoid waste.

Worked Example 1.1

A lender holds a mortgage on an apartment building in a lien theory state. The borrower defaults but continues to collect rents and fails to pay property taxes. The lender sues for foreclosure but does not take possession. Who is responsible for the unpaid taxes and rents before foreclosure?

Answer: The borrower (mortgagor) retains possession and is responsible for paying taxes and managing the property until foreclosure. The lender (mortgagee) cannot collect rents or take possession unless the borrower abandons the property or consents, or unless a receiver is appointed.

Worked Example 1.2

A mortgage contract states, "Borrower waives all rights to redeem the property after default." The borrower defaults and the lender forecloses. Can the borrower redeem the property before the foreclosure sale?

Answer: Yes. Any contractual waiver of the right to redeem before foreclosure is void as "clogging the equity of redemption." The borrower retains the right to redeem until the foreclosure sale is complete.

Exam Warning

The mortgagor’s right to redeem before foreclosure (equity of redemption) cannot be waived or limited by contract. Any such provision is void, even if agreed to by both parties.

Revision Tip

Remember: In most states, the mortgagor keeps possession and the right to rents and profits until foreclosure. The mortgagee’s remedies before foreclosure are limited.

Key Point Checklist

This article has covered the following key knowledge points:

• In lien theory states, the mortgagor retains possession until foreclosure; the mortgagee cannot take possession unless allowed by law or consent.
• The mortgagor must not commit waste; the mortgagee may sue for damages or seek an injunction if waste occurs.
• The mortgagor has an equity of redemption—the right to pay the debt and reclaim the property before foreclosure; this right cannot be waived or restricted by contract.
• If the mortgagee takes possession before foreclosure, they must manage the property prudently, account for rents, and avoid waste.
• A receiver may be appointed to manage the property and collect rents if necessary to protect the mortgagee’s security.
• Rents and profits belong to the mortgagor until foreclosure, unless the mortgagee takes possession or a receiver is appointed.

Key Terms and Concepts

• Lien Theory
• Title Theory
• Intermediate Theory
• Mortgagee in Possession
• Waste
• Equity of Redemption
• Clogging the Equity of Redemption
• Receiver