Mortgages/security devices - Rights and obligations

Learning Outcomes

This article explains mortgages and security devices for MBE purposes, including:

• Identifying and differentiating the main forms of real property security (mortgage, deed of trust, installment land contract, equitable mortgage, and related mortgage substitutes).
• Distinguishing lien, title, and intermediate theories of mortgages and predicting how each affects possession, joint tenancies, and the impact of default on possession and foreclosure strategy.
• Explaining the rights and obligations of mortgagors and mortgagees before and after default, including duties regarding waste, taxes, insurance, and rents.
• Applying the rules governing foreclosure methods, notice, necessary parties, and the effect of foreclosure on junior and senior interests.
• Analyzing equity and statutory rights of redemption, deeds in lieu of foreclosure, and limits on “clogging” the equity of redemption.
• Evaluating when deficiency judgments are available, how fair-value and anti-deficiency statutes constrain them, and how sale price affects remaining liability.
• Determining how transfers of mortgaged property (assumption vs. subject to), novation, and suretyship principles allocate personal liability on the debt.
• Understanding assignment of notes and mortgages, including how “the mortgage follows the note” and the consequences of holder-in-due-course status.
• Recognizing when installment land contracts, absolute deeds, and other security arrangements are treated as equitable mortgages for foreclosure, redemption, and priority purposes.
• Prioritizing competing interests using “first in time, first in right” rules, purchase-money and future-advance mortgage priority, and junior redemption of senior liens.

MBE Syllabus

For the MBE, you are required to understand mortgages and security devices in real property law, with a focus on the following syllabus points:

• The nature and types of security interests in real property (mortgage, deed of trust, installment land contract, equitable mortgage).
• The relationship between the promissory note and the mortgage; assignment of notes and mortgages.
• Rights and obligations of mortgagors (borrowers), including possession, waste, and redemption.
• Rights and obligations of mortgagees (lenders), including possession, collection of rents, and duties as mortgagee in possession.
• Pre-foreclosure rights and duties, including equity of redemption, “clogging,” and deeds in lieu of foreclosure.
• Foreclosure procedures (judicial and power-of-sale), notice requirements, and sale conduct.
• Priority rules among multiple mortgages and liens, and the effect of foreclosure on junior and senior interests.
• Redemption rights (equity of redemption and statutory redemption) and their timing.
• Deficiency judgments, fair-value and anti-deficiency statutes.
• Transfers of mortgaged property (assumption vs. taking subject to), novation, and suretyship issues.
• The impact of due-on-sale and acceleration clauses and of federal limits on enforcing them.
• The treatment of mortgage substitutes (installment land contracts, absolute deeds intended as security).

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 a right held by a mortgagor before foreclosure?
   1. Equity of redemption
   2. Statutory right of redemption (in all states)
   3. Right to a deficiency judgment
   4. Right to accelerate the debt
2. If a mortgagor sells property subject to a mortgage and the buyer assumes the mortgage, who is primarily liable to the lender after the sale?
   1. The mortgagor only
   2. The buyer only
   3. Both the mortgagor and the buyer
   4. The lender
3. In a foreclosure sale, which of the following interests is eliminated by the foreclosure of a senior mortgage (assuming proper notice)?
   1. Senior interests
   2. Junior interests
   3. The mortgagor’s equity of redemption
   4. The mortgagee’s right to a deficiency judgment

Introduction

A mortgage is the most common security device used to secure repayment of a loan with real property. Understanding the rights and obligations of both the borrower (mortgagor) and the lender (mortgagee) is essential for the MBE. This article covers the types of security interests, the parties’ duties, foreclosure procedures, and the consequences for both junior and senior interests.

Key Term: Mortgage
A security interest in real property that secures repayment of a debt, usually evidenced by a separate promissory note.

Key Term: Promissory Note
A written promise by the borrower to repay a specified sum on agreed terms; it is the personal obligation, while the mortgage is the security for that obligation.

Key Term: Security Device
Any legal arrangement that gives a creditor rights in a debtor’s property to secure repayment of a debt.

On the MBE, a wide range of transactions are treated as “mortgage substitutes.” The exam expects you to recognize these and apply the mortgage rules, especially to questions about default, foreclosure, and priority.

Types of Security Devices

Several forms of security interests are used in real property transactions. Functionally, they are all tested under mortgage principles.

• Mortgage: The borrower gives the lender a security interest in land to secure a loan. The mortgagor retains title and possession in most jurisdictions (lien theory), but the mortgage creates a lien that can be foreclosed if the borrower defaults.

• Deed of Trust: Similar to a mortgage, but a third-party trustee holds legal title until the debt is paid. On default, the trustee can usually sell the property under a nonjudicial “power-of-sale” procedure.

Key Term: Deed of Trust
A three-party security device in which the borrower conveys title to a trustee to secure a debt owed to the lender, with power in the trustee to sell the property on default.

• Installment Land Contract (Contract for Deed): The buyer makes payments to the seller over time. Traditionally, the seller kept title until the final payment and could declare a forfeiture on default. On modern exams, many courts treat the buyer’s interest much like an equitable mortgage and protect the buyer from harsh forfeitures.

Key Term: Installment Land Contract
A financing arrangement in which the buyer takes possession and pays the price in installments while the seller retains legal title as security.

Modern trends affecting installment contracts (frequently tested):

• If the buyer has made substantial payments, most courts:

  • Require a foreclosure sale rather than allowing the seller simply to forfeit payments and evict.
  • Allow the buyer some form of redemption (often modeled on the equity of redemption).

• Courts may consider the contract an equitable mortgage, especially where:

  • The buyer is in long-term possession.
  • The buyer has made significant improvements.
  • The “forfeiture” would resemble an extreme penalty.

• Equitable Mortgage: A transaction intended to serve as security for a debt, even if not labeled as a mortgage. For example, an “absolute deed” given as security rather than a true sale is treated as a mortgage in equity.

Key Term: Equitable Mortgage
A security interest arising by operation of equity when a conveyance or arrangement is intended as security for a debt, regardless of its form.

Common equitable-mortgage situations the MBE uses:

• A deed absolute given in exchange for a loan, with an oral agreement that the borrower can “buy back” the land.
• A conditional sale-and-repurchase arrangement where the “repurchase” price looks like repayment of a loan plus interest.
• A seller “retaining title” only as security in what is functionally a financed sale.

When in doubt, the MBE will treat any security device whose economic function is to secure a loan as a mortgage and will apply mortgage/foreclosure rules.

Theories of Title: Lien, Title, and Intermediate

Jurisdictions differ in their characterization of the mortgagee’s interest before foreclosure.

Key Term: Lien Theory
The majority approach in which the mortgage gives the lender a security lien only; title and the right to possession remain with the mortgagor until foreclosure.

Key Term: Title Theory
A minority approach in which the mortgage is viewed as transferring legal title to the mortgagee, who may have the right to immediate possession upon default.

Key Term: Intermediate Title Theory
A hybrid approach in which the mortgagor holds title until default, at which point title automatically passes to the mortgagee.

For the MBE, you must know:

• In lien theory states, the mortgagee cannot take possession before foreclosure solely because of default.
• In title theory states, the mortgagee can (at least theoretically) demand possession after default, even before foreclosure.
• In intermediate title states, possession rights change when default occurs.

An important exam wrinkle concerns joint tenancies:

• In a lien theory jurisdiction, a mortgage by one joint tenant does not sever the joint tenancy.
• In a title theory jurisdiction, a mortgage by one joint tenant typically severs the joint tenancy, because title is transferred to the mortgagee.

You may see a question asking who owns Blackacre when a joint tenant dies after mortgaging his interest; always ask which theory the jurisdiction follows.

Rights and Obligations of the Mortgagor (Borrower)

Rights

• Possession and Use: The mortgagor remains in possession and may use the property unless and until foreclosure or a proper transfer of possession. The mortgagor is entitled to rents and profits while in possession, subject to any valid assignment-of-rents clause.

• Equity of Redemption: The mortgagor has the right to redeem the property by paying off the debt at any time before the foreclosure sale.

Key Term: Equity of Redemption
The mortgagor’s right to stop foreclosure and recover full title by paying the outstanding mortgage debt (plus interest and costs) at any time before the foreclosure sale.

Redemption requires full payment of the accelerated balance plus allowable interest and costs; tendering only missed installments is insufficient once the lender has accelerated the debt.

• Right to Reinstatement (in many states): Before acceleration, if the borrower pays all past-due installments plus interest and late fees within a specified time after notice of default, the lender must treat the loan as current and may not accelerate. The MBE may mention this, but the detailed timing is state-specific and rarely tested.

• Right to Have the Mortgage Released: Upon full payment, the mortgagor is entitled to a satisfaction or release of the mortgage so that the lien no longer clouds title.

• Right to Transfer the Property: The mortgagor can sell or otherwise convey the property, subject to the existing mortgage, unless the mortgage expressly restricts transfer (e.g., via a due-on-sale clause). The mortgage follows the land; a transfer does not destroy the mortgage.

Mortgagors may also lease the property, even after the mortgage is given. The tenant’s leasehold is typically junior to the mortgage; a foreclosure of the mortgage can terminate the lease if it is junior and the tenant receives proper notice.

Obligations

• Repayment: The mortgagor must pay the debt as agreed in the note. Default (often nonpayment) triggers the lender’s rights to accelerate and foreclose.

• Maintenance, Taxes, and Insurance: The mortgagor must maintain the property and typically must pay property taxes and keep required insurance in place. Failure here can constitute default, allowing the lender to:

  • Advance funds to pay taxes or insurance and add the amount (plus interest) to the secured debt; or
  • Treat the failure as a default and accelerate/foreclose if the mortgage so provides.

• No Waste: The mortgagor must not commit waste that impairs the lender’s security.

Key Term: Waste
Conduct (or neglect) by the possessor that substantially reduces the value of the property as security, including affirmative waste, permissive waste (failure to repair), and sometimes destructive “ameliorative” changes.

Examples of waste that commonly appear on the MBE:

• Tearing down a valuable structure without replacing it.
• Removing fixtures (e.g., built-in appliances, trees, or timber) and selling them.
• Failing to make basic repairs so that the property deteriorates.
• Failing to pay taxes so that a tax sale threatens the property.

A mortgagor who commits waste may be liable to the mortgagee, especially if the property value falls below the debt balance. Junior lienholders can also seek to enjoin waste that impairs their security.

Rights and Obligations of the Mortgagee (Lender)

Rights (Mortgagee)

• Right to Foreclose: If the mortgagor defaults, and after any required notice and opportunity to cure, the mortgagee may accelerate the debt and foreclose to satisfy the obligation.

Key Term: Acceleration Clause
A clause allowing the lender, upon specified default (e.g., missed payments), to declare the entire loan balance immediately due.

The lender may sometimes choose to sue directly on the note rather than foreclosing (unless limited by “one-action” rules in some states, which the MBE rarely tests explicitly).

• Right to Possession (in some states):
  • In lien theory states, the lender generally has no right to possession before foreclosure.
  • In title or intermediate title states, the lender may be able to take possession upon default or after commencing foreclosure (this is fact-pattern dependent on the exam).

Key Term: Mortgagee in Possession
A mortgagee who has lawfully taken possession of the property (before or after foreclosure) and who must manage the property reasonably and account for rents and profits.

• Right to Rents and Profits: If the lender takes lawful possession as a mortgagee in possession, or if the mortgage includes an enforceable assignment-of-rents clause and the lender properly enforces it, the lender can collect rents and must apply them to the debt.

Key Term: Assignment of Rents
A clause giving the mortgagee the right, upon default, to collect rents from tenants and apply them to the mortgage debt.

• Right to a Deficiency Judgment: If the foreclosure sale proceeds are insufficient to cover the debt, the lender may seek a personal judgment for the remaining balance, unless barred or limited by statute.

Key Term: Deficiency Judgment
A personal judgment against the borrower (and any assuming grantee) for the unpaid balance of the mortgage debt after foreclosure proceeds are applied.

Obligations (Mortgagee)

• Good Faith and Commercial Reasonableness: The mortgagee must act in good faith and in a commercially reasonable manner in conducting the foreclosure sale. A grossly inadequate sale price, coupled with procedural irregularities (such as defective notice or collusion), may lead to setting aside the sale.

• Accounting Duties as Mortgagee in Possession: A lender in possession must:

  • Manage the property reasonably.
  • Use ordinary care to preserve the property.
  • Make necessary repairs and pay taxes and operating expenses from rents received.
  • Account to the mortgagor for rents and profits received, crediting them against the debt.

Failure to do so can result in liability or reduction of the debt.

• Duty to Apply Proceeds Properly: After foreclosure, the lender must apply sale proceeds in the correct order (discussed below under “Foreclosure and Priority”).

Pre-Foreclosure Rights and Duties

Key Term: Deed in Lieu of Foreclosure
A voluntary conveyance by the mortgagor of all interests in the property to the mortgagee in exchange for cancellation of the mortgage debt, as an alternative to foreclosure.

Instead of foreclosing, a lender may accept a deed in lieu of foreclosure. Exam points:

• It does not automatically wipe out junior mortgages or liens. The property remains subject to any junior interests, which can still be enforced against the property.
• The senior mortgage is merged into the new title and typically cannot later be foreclosed.
• Lenders often refuse to accept a deed in lieu when junior liens exist, because they would take the property still burdened by those liens.

Borrowers facing default may also negotiate:

• Forbearance agreements: The lender agrees to temporarily refrain from accelerating or foreclosing in exchange for additional payments, higher interest, or other terms.
• Loan modifications: Interest rate or term changes. On the exam, be aware that substantial modifications between the lender and an assuming grantee may release the original mortgagor (who is now a surety) from personal liability.

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

Clauses or side agreements made at the time the mortgage is created that waive the equity of redemption (“clogging” provisions) are generally invalid. The borrower cannot agree in advance never to redeem; the equity of redemption is jealously guarded.

However, a later agreement made after default, supported by fresh consideration, in which the borrower knowingly waives redemption rights, is more likely to be enforced.

Foreclosure and Priority

Key Term: Foreclosure
The legal process by which the mortgagee causes the mortgaged property to be sold and the proceeds applied to the mortgage debt after the mortgagor’s default.

Foreclosure is the process by which the mortgagee forces a sale of the property to satisfy the debt. Foreclosure affects the rights of other parties with interests in the property and must comply with statutory and procedural requirements (including notice to required parties).

Foreclosure Methods

Key Term: Judicial Foreclosure
A foreclosure conducted through a court-supervised lawsuit resulting in a court-ordered sale of the property.

Key Term: Power-of-Sale Foreclosure
A nonjudicial foreclosure based on a contractual power in a mortgage or deed of trust allowing the property to be sold by the lender or trustee upon default.

• In many states, mortgages and deeds of trust can be foreclosed either:
  • By judicial sale (always available), or
  • Under a power of sale (nonjudicial) if the instrument so provides, subject to statutory safeguards (notice, advertising, right to cure).

Nonjudicial foreclosure is faster and cheaper but must strictly comply with statutory requirements. Defects in notice or sale procedure can make the sale void or voidable.

Notice and Necessary Parties

The mortgagee must give proper notice of the foreclosure sale to:

• The mortgagor.
• All holders of subordinate interests (junior mortgages, judgment liens, etc.) whose interests the lender seeks to terminate.

Failure to notify a junior interest holder means that junior interest is not cut off by the sale and continues to encumber the property.

It is also essential to join all necessary parties:

• Mortgagor: Needed so any deficiency judgment can be entered and equity of redemption extinguished.
• Junior lienholders: Needed so their liens can be cut off.
• Omission of a necessary party:
  • The foreclosure is still valid as between the lender, mortgagor, and properly joined parties.
  • The omitted junior lienholder’s interest is not affected; the property is still subject to that lien, and the junior can foreclose later, potentially wiping out the foreclosure buyer’s title.

Priority of Interests

• First in Time, First in Right: Generally, earlier-recorded mortgages have priority over later-recorded interests, subject to:
  • Recording act rules (notice, race, or race-notice).
  • Special priority rules (e.g., purchase-money mortgages often take priority over prior non–purchase-money liens).

Key Term: Purchase-Money Mortgage (PMM)
A mortgage given to a lender (or seller) to secure funds used to acquire the property, executed at or very near the time of the purchase.

Special priority of a PMM:

• A properly recorded PMM usually has priority over earlier liens and judgments against the mortgagor, but only as to the portion of the loan used to acquire the property.
• If there are two PMMs (e.g., bank PMM and seller PMM), priority between them is usually determined by recording order.

Key Term: Future-Advance Mortgage
A mortgage that secures not only an initial loan but also future advances the lender may make to the borrower.

• If advances are obligatory under the agreement, they generally retain the priority date of the original mortgage.

• If advances are optional, advances made with notice of an intervening lien are often subordinated to that intervening lien.

• Senior vs. Junior Interests:

  • Foreclosure of a senior mortgage typically:
    • Wipes out junior interests that are properly joined and notified.
    • Leaves senior interests unaffected (the buyer at the sale takes subject to them).
  • Junior lienholders have the right to pay off (redeem from) a senior lien to protect their position before foreclosure.

• Effect on the Mortgagor: Foreclosure terminates the mortgagor’s equity of redemption and, absent statutory redemption, ends the owner’s interest in the property.

Sale proceeds are applied in this order:

• Costs of the sale (trustee’s fees, advertising, court costs).
• Foreclosing mortgage.
• Junior interests in order of priority.
• Any surplus to the mortgagor.

If proceeds are insufficient, the foreclosing lender may seek a deficiency judgment (if allowed), and wiped-out junior lienholders may pursue the mortgagor personally on the secured debt (they still possess the note).

Worked Example 1.1

A homeowner in default on her mortgage receives notice of a foreclosure sale scheduled in 30 days. She offers to pay the full amount owed, including interest and costs, before the sale. Does she have the right to stop the foreclosure?

Answer:
Yes. The homeowner has the right of equity of redemption, allowing her to pay the full accelerated debt (plus interest and allowable costs) and reclaim the property at any time before the foreclosure sale.

Redemption Rights

Two separate concepts are commonly tested.

• Equity of Redemption: As discussed above, the mortgagor may redeem the property by paying the full debt before the foreclosure sale. This right exists in every state unless validly cut off by a foreclosure.

• Statutory Redemption: In some states, after the foreclosure sale, the mortgagor (and sometimes junior lienholders) may redeem the property by paying the sale price (or a statutorily defined amount) within a fixed period.

Key Term: Statutory Redemption
A state-granted right, available in some jurisdictions, allowing the mortgagor (or other specified parties) to recover the property after a foreclosure sale by paying the foreclosure purchaser the statutorily defined redemption amount within a limited time.

Key exam points:

• Equity of redemption operates before the sale; statutory redemption (if available) operates after the sale.
• Statutory redemption extinguishes the purchaser’s title and restores ownership to the redeeming party.
• In some states, statutory redemption may eliminate or reduce any deficiency judgment.
• If statutory redemption exists, the borrower often remains in possession during the redemption period.

Deficiency Judgments

If the foreclosure sale proceeds are insufficient to cover the debt, the mortgagee may seek a deficiency judgment for the balance, unless prohibited or limited by statute.

Some states:

• Prohibit deficiency judgments after nonjudicial foreclosure on certain residential purchase-money mortgages.
• Require a fair-value hearing, limiting the deficiency to the difference between the debt and the property’s fair market value (not the potentially lower sale price).

Key Term: Fair-Value Statute
A statute that limits a mortgagee’s deficiency judgment to the difference between the debt and the property’s fair market value, rather than the foreclosure sale price.

Key Term: Anti-Deficiency Statute
A statute that either bars or strictly limits deficiency judgments, often for nonjudicial or purchase-money residential foreclosures.

On the MBE, statutes may be given in the fact pattern. You must:

• Identify when a lender can pursue a deficiency.
• Recognize when statutes (anti-deficiency or fair-value laws) bar or limit that remedy.

Transfers and Due-on-Sale Clauses

Transfer by Mortgagor

The mortgagor may freely transfer the property, but the mortgage remains as a lien on the land unless released.

Two common structures:

Key Term: Assumption of Mortgage
A transaction in which the grantee agrees to become personally liable on the existing mortgage debt in addition to the original mortgagor.

Key Term: Taking Subject To the Mortgage
A transaction in which the grantee takes title acknowledging the existing mortgage but does not assume personal liability for the debt.

• Assumption:
  • The buyer (grantee) becomes primarily liable on the mortgage debt.
  • The original mortgagor becomes secondarily liable (like a surety).
  • The lender can sue both, unless it releases the original mortgagor.
  • If the lender and assuming buyer modify the loan in a way that increases the risk to the original mortgagor (e.g., higher interest rate), the original mortgagor may be discharged from personal liability as a surety.

Key Term: Novation
An agreement among the creditor, the original debtor, and a new debtor to substitute the new debtor and release the original debtor from the obligation.

If the lender agrees to a novation when the buyer assumes, the original mortgagor is fully released.

• Subject To:
  • The buyer is not personally liable for the debt.
  • The mortgagor remains personally liable.
  • The lender can foreclose against the land but cannot obtain a personal judgment against the buyer.

If the deed is silent or ambiguous, most jurisdictions presume that the buyer takes subject to the mortgage.

Transfer by Mortgagee

The lender may assign the note and mortgage to another lender or investor.

Key Term: “The Mortgage Follows the Note”
A principle under which transfer of the promissory note automatically carries the mortgage with it.

• The note and mortgage travel together:
  • Transfer of the note automatically carries the mortgage.
  • Attempted transfer of the mortgage alone is generally ineffective or treated as also transferring the note.

A holder in due course of the note (if negotiable and properly endorsed) may take free of many personal defenses, but the mortgage remains subject to real-property defenses and interests (e.g., prior recorded liens).

Due-on-Sale and Acceleration Clauses

Key Term: Due-on-Sale Clause
A provision allowing the lender to require immediate repayment of the entire loan if the mortgaged property is sold or transferred without the lender’s consent.

Due-on-sale clauses allow the lender, at its option, to accelerate the loan if the mortgagor transfers the property. Exam implications:

• The clause is enforceable in most situations under federal law, but the remedy is acceleration and foreclosure—not automatic personal liability for a transferee who merely takes subject to the mortgage.
• The clause is usually found in the note, not the mortgage, and binds the original borrower; a buyer who takes subject to is not personally liable simply because a due-on-sale clause exists.
• A due-on-encumbrance clause (accelerating if the mortgagor gives a junior mortgage) is sometimes also enforceable; the exam may treat such a clause like a due-on-sale clause.

Key Term: Mortgagee in Possession
(Reintroduced for clarity) A mortgagee who has taken lawful possession of the mortgaged property and who must manage it prudently, account for rents, and preserve the security.

Worked Example 1.2

A mortgagor sells property to a buyer who assumes the mortgage. The buyer later defaults, and the lender forecloses. The foreclosure sale does not cover the full debt. Who is liable for the deficiency?

Answer:
Both the original mortgagor and the buyer who assumed the mortgage are personally liable for the deficiency, unless the lender released the seller. As between the two, the buyer (who assumed) is primarily liable, and the seller is in the position of a surety.

Worked Example 1.3

A couple gives Bank a first mortgage on their home, then later grants a second mortgage to a savings association. They default on both loans. Bank accepts a deed in lieu of foreclosure from the couple and cancels the first mortgage. Bank does not reserve any right to foreclose. What happens to the second mortgage?

Answer:
The property remains subject to the second (junior) mortgage. Acceptance of a deed in lieu of foreclosure by the senior mortgagee does not cut off junior interests. The junior lender can still foreclose against the property.

Worked Example 1.4

Owner sells Blackacre to Buyer. The deed states that Buyer “assumes and agrees to pay” the existing mortgage. Buyer later defaults. The lender sues only Owner for the unpaid balance. Owner pays and then sues Buyer for reimbursement. Is Owner entitled to recover?

Answer:
Yes. Because Buyer assumed the mortgage, Buyer is primarily liable on the debt and Owner is in the position of a surety. After Owner pays the lender, Owner may recover from Buyer the amount paid.

Worked Example 1.5

Mortgagor sells property to Purchaser “subject to” an existing mortgage. The note contains a due-on-sale clause. Mortgagor stops making payments, and the lender sues Purchaser personally for the full accelerated balance, without foreclosing. Is Purchaser liable?

Answer:
No. Purchaser took subject to the mortgage and did not assume personal liability. The due-on-sale clause allows the lender to accelerate and foreclose, but does not by itself create personal liability in Purchaser.

Worked Example 1.6

A bank forecloses its senior mortgage but fails to give required notice to a properly recorded junior mortgagee. The property is sold to a third-party buyer. What is the status of the junior mortgage?

Answer:
The junior mortgage is not cut off by the sale because the junior holder was not given notice and joined as required. The property remains subject to the junior mortgage, and the junior lender can still foreclose against the buyer.

Worked Example 1.7

Seller gives Buyer a purchase-money mortgage for part of the purchase price of Blackacre. Two months earlier, Seller had given a general judgment creditor a lien that was properly recorded. Buyer later defaults, and Seller forecloses. Which interest has priority in the sale proceeds?

Answer:
The purchase-money mortgage has priority over the earlier judgment lien, at least to the extent of the funds used to acquire Blackacre. A properly recorded purchase-money mortgage usually takes precedence over prior non–purchase-money liens against the mortgagor.

Worked Example 1.8

Lender forecloses a senior mortgage. It joins and gives notice to the mortgagor, but mistakenly fails to join a recorded second mortgagee. The foreclosure buyer pays fair value. One year later, the second mortgagee forecloses. What happens to the foreclosure buyer’s title?

Answer:
The second mortgage was not cut off by the first foreclosure, so the property remains subject to it. The junior mortgagee can foreclose and sell the property, potentially wiping out the buyer’s title. The buyer may, however, pay off the junior mortgage to protect his title or seek subrogation to the senior lender’s rights.

Worked Example 1.9

Bank holds a first mortgage. Later, Borrower gives a second mortgage to FinanceCo. After the second mortgage is recorded, Bank and Borrower agree to raise the interest rate and extend the term of the first mortgage, significantly increasing the total interest due. Bank then forecloses. As against FinanceCo, what is the effect of the modification?

Answer:
The original first mortgage retains its senior priority as to the original principal amount. However, to the extent the modification materially prejudices the junior lienor (e.g., increased interest beyond what was agreed when FinanceCo lent), the modification is junior to FinanceCo’s interest.

Worked Example 1.10

State law provides that no deficiency judgment is permitted after a nonjudicial foreclosure of a purchase-money mortgage on an owner-occupied residence. Bank holds such a mortgage and forecloses under a power of sale. The sale brings less than the loan balance. May Bank obtain a deficiency judgment?

Answer:
No. The anti-deficiency statute bars a deficiency judgment in this type of case. Bank’s only remedy is to take and keep the foreclosure proceeds.

Exam Warning

In a foreclosure, failure to notify junior interest holders (such as second mortgagees or lienholders) may result in their interests surviving the sale. Always check that proper notice was given to all necessary parties. Also remember that a deed in lieu of foreclosure does not cut off junior interests: the property remains subject to those liens.

Revision Tip

Remember: Foreclosure of a properly noticed senior mortgage wipes out junior interests but not senior ones. The buyer at a foreclosure sale takes subject to any senior mortgages, and sale proceeds are applied first to the foreclosing lender, then to junior interests in order of priority.

Also: Distinguish clearly between assumption and “subject to” for transfer questions; that distinction controls who is personally liable for any deficiency.

Key Point Checklist

This article has covered the following key knowledge points:

• A mortgage is a security interest in real property securing a debt evidenced by a promissory note; the note is the personal obligation, the mortgage is the security.
• Deeds of trust, installment land contracts, absolute deeds intended as security, and other mortgage substitutes are all tested under mortgage principles.
• Lien theory, title theory, and intermediate title theory affect who has the right to possession before foreclosure and whether a mortgage by one joint tenant severs the joint tenancy.
• Mortgagors have rights to possession, equity of redemption, and (in some states) statutory redemption, and duties to pay, maintain, and avoid waste.
• Mortgagees have rights to accelerate, foreclose, take possession in some jurisdictions, collect rents (especially as mortgagee in possession or under an assignment-of-rents clause), and seek deficiency judgments (subject to statutory limits).
• Pre-foreclosure options include reinstatement, redemption, deeds in lieu, forbearance, and modification; attempts made at creation of the mortgage to “clog” the equity of redemption are generally invalid.
• Foreclosure methods include judicial and power-of-sale procedures; both require proper notice, joinder of necessary parties, and must be conducted in good faith and in a commercially reasonable manner.
• Priority generally follows “first in time, first in right,” but purchase-money mortgages and some future-advance mortgages receive special treatment.
• Foreclosure terminates junior interests that receive notice and are joined, but does not affect senior interests; omitted junior interests survive.
• Equity of redemption operates before sale; statutory redemption (where available) operates after sale and can unwind the purchaser’s title.
• Deficiency judgments are often available after foreclosure but may be restricted or barred by anti-deficiency and fair-value statutes.
• Transfers of mortgaged property affect personal liability depending on whether the buyer assumes the mortgage or takes subject to it; novation can fully release the original borrower.
• Due-on-sale and acceleration clauses allow lenders to call loans on transfer or default but do not themselves create personal liability in transferees who have not assumed the debt.
• The mortgage “follows the note” when the lender assigns the debt; transfer of the note carries the security with it, and holder-in-due-course rules may affect personal defenses on the note.

Key Terms and Concepts

• Mortgage
• Security Device
• Promissory Note
• Deed of Trust
• Installment Land Contract
• Equitable Mortgage
• Lien Theory
• Title Theory
• Intermediate Title Theory
• Equity of Redemption
• Statutory Redemption
• Foreclosure
• Judicial Foreclosure
• Power-of-Sale Foreclosure
• Deficiency Judgment
• Fair-Value Statute
• Anti-Deficiency Statute
• Deed in Lieu of Foreclosure
• Assumption of Mortgage
• Taking Subject To the Mortgage
• Acceleration Clause
• Due-on-Sale Clause
• Mortgagee in Possession
• Assignment of Rents
• Purchase-Money Mortgage
• Future-Advance Mortgage
• Novation
• Waste
• Clogging the Equity of Redemption
• “The Mortgage Follows the Note”