Mortgages/security devices - Rights and duties prior to fore...

Learning Outcomes

This article explains the rights and duties of mortgagors and mortgagees before foreclosure, including:

• How lien, title, and intermediate theories allocate present title, possession, and entitlement to rents, and why that classification matters on MBE fact patterns.
• The circumstances in which the mortgagee can lawfully take possession before foreclosure—default, abandonment, consent, or operation of title/intermediate theory—and the legal consequences of becoming a mortgagee in possession.
• The mortgagor’s duty to avoid voluntary, permissive, and ameliorative waste, what counts as “impairment of security,” and the range of remedies available to the mortgagee.
• The nature and operation of the equity of redemption, including when redemption is available, what amount must be tendered, and how acceleration clauses affect the redemption price.
• The doctrine prohibiting “clogging” the equity of redemption, common exam-tested clauses that are invalid, and how to distinguish an impermissible clog from a valid, independent option.
• How deeds in lieu of foreclosure, assignments of rents, and court‑appointed receiverships shift control of the property and income stream without immediately eliminating junior interests.
• The accounting, management, and repair duties imposed on a mortgagee in possession, and how failures in those duties adjust the outstanding debt when the mortgagor redeems or the property is sold.

MBE Syllabus

For the MBE, you are required to understand the legal relationship between mortgagor and mortgagee before foreclosure, with a focus on the following syllabus points:

• The right to possession of the mortgaged property prior to foreclosure under lien, title, and intermediate theories
• The mortgagor’s duty not to commit waste and the mortgagee’s remedies for waste
• The concept of equity of redemption, including timing and the prohibition on clogging this right
• The effect of abandonment, consent, assignments of rents, and court-appointed receiverships
• The allocation of rents and profits before foreclosure
• The consequences of a 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 precise rules vary by state, but a core set of concepts appears repeatedly in MBE questions:

• Who has the right to possess the property before foreclosure?
• What limits exist on the mortgagor’s use of the property (especially waste)?
• How and when can the mortgagor redeem the property?
• What happens if the mortgagee takes possession or a receiver is appointed?
• Who gets the rents and profits before foreclosure?

Understanding these issues requires first understanding how states characterize the mortgage interest.

Key Term: Mortgage
A security interest in real property that secures repayment of a debt. The mortgagor is the borrower; the mortgagee is the lender.

Theories of Title and Possession

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

• Lien Theory (majority): The mortgage is a lien (security interest) only. The mortgagor retains legal and equitable title and the right to possession until foreclosure.
• Title Theory (minority): The mortgage transfers legal title to the mortgagee, who technically may take possession at any time, even before default.
• Intermediate Theory (minority hybrid): The mortgagor keeps title and possession until default; after default, legal title or the immediate right to possession passes to the mortgagee, even before foreclosure.

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 mortgagor retains title and possession until default, after which the mortgagee may take possession prior to foreclosure.

Practical Consequences by Theory

On the MBE, the label (lien vs. title vs. intermediate) mainly affects three things:

• Who is entitled to possession before foreclosure.
• Who presumptively receives rents and profits.
• Whether the mortgagee can become a mortgagee in possession without the mortgagor’s default or consent.

Under all theories, the mortgagor remains the equitable owner and retains the equity of redemption (discussed later).

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 mortgagor’s possession is not a default and does not require the lender’s consent. The mortgagee cannot take possession before foreclosure unless:

• The mortgagor abandons the property.
• The mortgagor consents to mortgagee possession.
• State law (often title or intermediate theory) gives the mortgagee that right after default.

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.

In a title theory jurisdiction, the mortgagee has legal title and could, in theory, take possession immediately after the mortgage is granted. In practice, lenders usually do not do this. On the exam, however, if you are told the state follows a pure title theory and the mortgage says nothing about possession, a mortgagee who chooses to take possession is usually allowed to do so even before default.

In an intermediate theory state, the mortgagee can take possession only after default but before foreclosure. This can matter in questions where the lender wants to step in and collect rents immediately after default.

Possession, Tenants, and Leases

A mortgagor in possession may:

• Occupy the property personally.
• Lease the property to tenants (ordinary landlord–tenant rules apply).
• Sell the property, in which case the buyer takes subject to the mortgage unless the mortgage is discharged.

Any lease granted by the mortgagor before foreclosure is typically binding on a mortgagee who later forecloses, at least until the lender exercises foreclosure rights. Tenants often must attorn (recognize the lender as their new landlord) after foreclosure; before foreclosure, their rent belongs to the mortgagor unless the mortgagee has lawfully taken possession or a receiver has been appointed.

Abandonment and Consent

If the mortgagor abandons the property (e.g., moves out, leaves it vacant, stops maintaining it), the mortgagee may usually enter and take possession to protect its security, particularly in lien theory states where the lender otherwise has no right to possession.

The mortgagor can also consent to mortgagee possession in a separate agreement or in the mortgage instrument itself. Even when possession is taken by consent, the mortgagee in possession assumes significant duties (discussed below).

The key exam point: once the mortgagee lawfully takes possession (by theory of title, default, abandonment, or consent), it is a mortgagee in possession and cannot act like an ordinary owner. Its possession is for security purposes only.

Duties of the Mortgagor: Waste

The mortgagor must not commit waste that impairs the mortgagee’s security. Waste is any act or omission that reduces the value of the property so that the lender’s ability to be repaid from the collateral is threatened.

Waste commonly appears in three forms:

• Voluntary (affirmative) waste: Deliberate acts that damage or diminish the property’s value (e.g., tearing out fixtures, removing valuable topsoil or timber, demolishing structures).
• Permissive waste: Failure to maintain the property, pay property taxes, pay insurance premiums, or prevent deterioration.
• Ameliorative waste: Changes that increase market value but substantially alter the property’s character (e.g., converting a historic residence into a commercial space). This is generally less of a concern to mortgagees unless the change increases risk or violates zoning or covenant restrictions.

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

When Is Waste Actionable

Waste is actionable when it impairs the security—i.e., when the property value falls below the outstanding mortgage balance, or there is a substantial risk it will.

Examples:

• Mortgagor stops paying taxes and the property becomes subject to tax sale.
• Mortgagor allows the roof to leak and the building deteriorates drastically.
• Mortgagor intentionally strips fixtures (built‑in appliances, HVAC, lighting) and sells them.

If the property value comfortably exceeds the mortgage debt, some deterioration may not be actionable because the security is not impaired. The exam will usually signal impairment by stating that the value of the property has dropped below the loan balance or that the lender is “insecure.”

Mortgagee’s Remedies for Waste

If the mortgagor commits waste, the mortgagee may:

• Sue for damages to restore its security position.
• Seek an injunction to stop ongoing or threatened waste.
• In some cases, accelerate the debt or treat the waste as an event of default if the mortgage instrument so provides.

The mortgagee normally does not get ownership simply because waste occurred; foreclosure is still required to cut off the mortgagor’s equity of redemption.

Equity of Redemption

The mortgagor has the right to redeem the property by paying the full mortgage debt (plus interest and usually reasonable foreclosure costs and attorney’s fees) at any time before the foreclosure sale. This common-law right is called the equity of redemption.

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.

Redemption requires paying:

• The full accelerated balance if the debt has been properly accelerated.
• All accrued interest.
• Reasonable costs of foreclosure and fees, if the mortgage or state law so provides.

A tender of only the past‑due installments is not enough once the debt has been accelerated.

Once a valid foreclosure sale occurs, the equity of redemption is cut off. Some states provide a separate statutory right of redemption after the foreclosure sale, but that is distinct from the common-law equity of redemption and is tested as a post‑foreclosure concept.

Key Term: Statutory Right of Redemption
A state‑created right allowing the mortgagor (or certain other parties) to redeem the property for a set period after the foreclosure sale by paying the sale price or the debt, plus costs.

On the MBE, if the fact pattern states that the owner tries to pay before the foreclosure sale, the right being tested is almost always the equity of redemption, not statutory redemption.

Key Term: Deed in Lieu of Foreclosure
A negotiated arrangement in which the mortgagor conveys the property to the mortgagee instead of undergoing foreclosure, in exchange for release from the mortgage debt.

A deed in lieu is an alternative way to end the mortgagor’s equity of redemption—by voluntary conveyance rather than sale. It does not automatically wipe out junior liens; the property remains subject to any junior mortgages unless those creditors agree otherwise.

Clogging the Equity of Redemption

Any attempt to waive or restrict the mortgagor’s right to redeem in the mortgage transaction itself is void as “clogging” the equity of redemption. Courts treat the equity of redemption as inseparable from a mortgage.

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

Common examples of impermissible clogs:

• A clause in the mortgage saying, “Borrower waives all rights to redeem after default.”
• A mortgage plus a contemporaneous option giving the lender the right to purchase the property for a fixed price if the borrower defaults, in circumstances suggesting the option is effectively a forfeiture device.

Courts are especially suspicious when the lender appears to be trying to obtain both the debt and the property on default, without providing a meaningful redemption opportunity.

Important distinction: A separate option to purchase given to the lender in an unrelated later transaction, for fair consideration, may be upheld. The closer in time and circumstances the “option” is to the mortgage, the more likely it is treated as a clogged equity of redemption.

Mortgagee in Possession: Duties and Liabilities

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

• Manage the property as a prudent owner.
• Collect rents and profits and apply them to the mortgage debt.
• Pay property taxes and necessary operating expenses.
• Make reasonable repairs and prevent waste.
• Keep clear and accurate records and account to the mortgagor.

The mortgagee in possession is not required to make major improvements, but if it does so, it usually cannot charge the mortgagor for them except to the limited extent that they actually increase the security and are consistent with prudent management.

A mortgagee in possession is liable for:

• Losses caused by its mismanagement or failure to exercise ordinary care.
• Rents and profits actually collected (and sometimes those that should have been collected with reasonable diligence).

The mortgagee must credit net rents (rents minus necessary expenses) against the mortgage debt. Taking possession does not convert the mortgagee into the property’s absolute owner; legal title remains where state law puts it, and equitable ownership remains with the mortgagor until foreclosure or voluntary conveyance.

Key Term: Mortgagee in Possession
A mortgagee who lawfully takes possession of the mortgaged property before foreclosure and must manage prudently, prevent waste, and account for all rents and profits.

Receiverships

Sometimes neither the mortgagor nor the mortgagee is well positioned to manage the property. If the mortgagor is in default and the property (especially income‑producing property) is at risk of waste, loss, or mismanagement, the mortgagee may ask the court to appoint a receiver.

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

A receiver:

• Takes possession of the property, usually displacing the mortgagor.
• Collects rents and profits.
• Pays necessary operating expenses and taxes.
• Remits net income to the court, usually to be applied to the mortgage debt.

Courts are more likely to appoint a receiver when:

• The property is income‑producing (e.g., apartment buildings, shopping centers).
• The mortgagor is insolvent or clearly mismanaging the property.
• The security is inadequate (collateral value is less than the debt).
• The mortgage contains an assignment of rents clause authorizing a receiver upon default.

Key Term: Assignment of Rents
A clause in a mortgage or separate agreement giving the mortgagee rights to collect rents from the property, often upon default or appointment of a receiver.

On the exam, if you see an income‑producing property plus default plus evidence of waste or nonpayment of taxes, a receiver is a likely remedy when the lender seeks protection without yet having foreclosed.

Rents and Profits

Unless otherwise agreed or unless the mortgagee has taken possession or a receiver has been appointed, the mortgagor is entitled to rents and profits from the property before foreclosure. This is the default rule in lien theory states.

If the mortgagee takes possession or a receiver is appointed:

• Rents and profits are collected by the mortgagee in possession or receiver.
• After paying necessary expenses, net income is applied to reduce the mortgage debt.

In some states, an assignment of rents clause becomes effective automatically on default, allowing the mortgagee to notify tenants to pay their rent directly to the lender even without taking possession. In others, the clause becomes effective only when the mortgagee takes additional steps (such as obtaining a receivership).

For MBE purposes, unless the facts clearly give the lender possession or a receiver, assume that rents belong to the mortgagor before foreclosure.

Abandonment and Consent (Revisited)

If the mortgagor abandons the property or affirmatively consents, the mortgagee may take possession and must then behave as a mortgagee in possession. Abandonment or consent doesn’t eliminate the mortgagor’s equity of redemption; it simply shifts possession and management responsibilities.

The mortgagor remains liable on the debt unless the lender clearly releases that liability (for example, through a deed in lieu of foreclosure that expressly discharges the obligation).

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. The lender’s remedy is to foreclose and, if necessary, seek appointment of a receiver to protect the security.

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 by paying the full accelerated debt plus interest and allowable costs.

Worked Example 1.3

A homeowner in a lien theory state falls behind on mortgage payments. To save time and costs, the bank and homeowner agree that the bank will take a deed in lieu of foreclosure and release the homeowner from personal liability. Unknown to the bank, there is a junior mortgage on the property. After the deed in lieu, the junior lender seeks to foreclose. Is the junior mortgage still valid?

Answer:
Yes. A deed in lieu of foreclosure transfers whatever interest the mortgagor still has, but it does not automatically eliminate junior interests. Because the senior lender accepted a deed instead of foreclosing, the junior mortgage is not cut off and remains attached to the property. The junior lender may foreclose against the bank as the new owner.

Worked Example 1.4

In a title theory state, a mortgagee takes possession of a small shopping center after the mortgagor defaults. The mortgagee collects rents from tenants but fails to repair a leaking roof, causing serious damage to several units and loss of rental income. When the mortgagor later redeems, what accounting is required?

Answer:
As a mortgagee in possession, the mortgagee must manage the property as a prudent owner and account for all rents and profits. The mortgagee must credit against the debt all rents actually collected, plus rents that should have been collected but for its unreasonable failure to maintain the premises. The mortgagor can seek a reduction in the debt for losses caused by the mortgagee’s mismanagement.

Worked Example 1.5

A commercial building is subject to a mortgage that includes an assignment of rents clause. The mortgagor defaults and stops paying taxes. Tenants continue to pay rent to the mortgagor. The lender sues for foreclosure and asks the court to appoint a receiver. What is the likely outcome regarding the rents?

Answer:
The court is likely to appoint a receiver because the property is income‑producing, the mortgagor is in default, taxes are not being paid, and there is an assignment of rents clause. The receiver will collect the rents going forward, pay taxes and necessary expenses, and apply net income to the mortgage debt. Past rents already paid to the mortgagor typically remain with the mortgagor absent fraud or special circumstances.

Exam Warning

The mortgagor’s right to redeem before foreclosure (equity of redemption) cannot be waived or limited by contract in the mortgage transaction. Any such provision is void, even if agreed to by both parties. Be careful to distinguish this from a separate, later option contract, which may be valid if it is genuinely independent of the mortgage.

Revision Tip

Remember: In most states, the mortgagor keeps possession and the right to rents and profits until foreclosure. The mortgagee’s pre‑foreclosure remedies are limited: sue on the note, seek injunction or damages for waste, request a receiver, or foreclose. Taking possession brings burdens as well as benefits.

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, by default under intermediate/title theory, abandonment, or consent.
• In title theory states, the mortgagee holds legal title and may, in principle, take possession even before default, though this triggers mortgagee‑in‑possession duties.
• The mortgagor must not commit waste that impairs the mortgagee’s security; the mortgagee may sue for damages, seek an injunction, or rely on default provisions if waste occurs.
• The mortgagor has an equity of redemption—the right to pay the full debt (usually the accelerated balance plus interest and costs) and reclaim the property before foreclosure; this right cannot be waived or restricted in the mortgage transaction.
• Attempts to clog the equity of redemption—such as waiver clauses or forfeiture‑like options tied to the mortgage—are void.
• A deed in lieu of foreclosure is a consensual way to end the mortgagor’s equity of redemption but does not automatically cut off junior liens.
• If the mortgagee takes possession before foreclosure, it becomes a mortgagee in possession and must manage the property prudently, pay taxes and necessary expenses, avoid waste, and strictly account for all rents and profits.
• A receiver may be appointed to manage the property and collect rents when the mortgagor is in default and the security is threatened, particularly for income‑producing property.
• Rents and profits belong to the mortgagor until foreclosure, unless the mortgagee takes possession, an assignment of rents is enforced, or a receiver is appointed.
• Abandonment or consent allows the mortgagee to take possession, but does not extinguish the mortgagor’s equity of redemption or personal liability on the debt unless clearly released.

Key Terms and Concepts

• Mortgage
• Lien Theory
• Title Theory
• Intermediate Theory
• Equity of Redemption
• Statutory Right of Redemption
• Clogging the Equity of Redemption
• Deed in Lieu of Foreclosure
• Mortgagee in Possession
• Waste
• Receiver
• Assignment of Rents