Transfer by the Mortgagor Transfer of mortgaged land is subject to derivative title rule In other words, the existing mortgage remains effective against the land following transfer, unless: (1) the mortgagor pays off the mortgage and mortgage is released (the typical case in sale transactions), or (2) the mortgage is unrecorded and the transferee is a BFP entitled to protection of recording act Transfer by the Mortgagor Litton owns home subject to mortgage held by Bank 10 years left on mortgage term; balance = $200,000 Litton contracts to sell to Wells Rather than paying off the existing mortgage, contract provides that Wells will take over making monthly payments on the mortgage Why might Litton and/or Wells want to structure the transaction this way? Why might Bank agree or refuse? Buyer Might Want to Take Over Existing Mortgage Because: Buyer may not qualify for a conventional loan Buyer may want to avoid fees/closing costs associated with a new loan If current interest rates are >> than existing rate on Seller s loan, Buyer would rather take over payments on Seller s current loan (new loan would mean higher payments) Lender Might Not Want to Allow the Loan to Be Taken Over by Buyer Because: Buyer may not be creditworthy, or Buyer s proposed use of the land may be inappropriate or threaten Lender s security Lender may want to earn fees associated with new loan If interest rates are now higher, Lender would prefer to call the existing loan (under due on sale clause) and make a new loan to Buyer at the now-higher market rate
Lender Might Consent to Allow Buyer to Take Over Loan If: Interest rate on the existing loan is equal to or above the existing market rate, and Buyer is an acceptable risk (income and proposed use), and Buyer will agree to pay any fee for Lender s consent to the transfer Such fees for Lender to waive its rights under a due on sale clause are permissible Transfer of Mortgaged Property Nearly all mortgage loan documents contain a due-onsale or due-on-transfer clause If Mortgagor transfers mortgaged property without Mortgagee s prior consent, Mortgagee can declare default, accelerate debt, and foreclose Thus, a Buyer effectively can t take over an existing mortgage without Mortgagee s consent Transfers by the Mortgagor If the existing mortgage isn t paid off at the time of transfer, then the grantee takes the land either: Subject to the mortgage (the lien remains effective, but the grantee does not become personally liable on the debt), or By assuming the debt (the lien remains effective, and the grantee also assumes personal liability on the debt if the debt is not repaid) In this situation, a transfer is a subject to transfer unless the grantee makes an express promise to assume personal liability [Middleton v. Hancock, p. 478] Transfers by the Mortgagor If Wells is not going to pay off Litton s mortgage at the time of the sale, but is going to take over making payments, why wouldn t the Bank require Wells to assume the mortgage? Why would it ever allow a subject to transfer?
Sale Hypo Mortgagor loses job, goes into default on mortgage loan (held by Bank) Mortgage balance = $275,000 FMV of property = $250,000 Mortgagor proposes to sell to Buyer for $250,000; Buyer will take subject to existing mortgage Should Bank agree? Or should it require Buyer to assume mortgage? Generally, mortgagee is better off if grantee assumes the mortgage debt Mortgagee would then have two parties liable in event of default (assumption does not automatically result in release of the original borrower) But, with distressed properties (where mortgagee may not want to foreclose), mortgagee may consent to subject to transfer if proposed Buyer is not willing to assume Mortgagee might agree, in order to have a performing loan than a defaulted one, if Buyer s is the best offer Transfers by the Mortgagor: Key Points A transfer of mortgaged property (where the mortgage isn t being paid off and released) is a subject to transfer, unless the grantee makes an express promise to assume personal liability [Middleton v. Hancock, p. 478] If the grantee assumes the mortgage debt, that does not automatically release the original mortgagor Mortgagor/transferor remains liable on the mortgage debt, unless the mortgagee expressly agrees to release him/her If the mortgagee does not release the original mortgagor following the transfer, the original mortgagor (who remains liable for the debt) is in the position of a surety A surety is one who stands liable for another s debt E.g., Bank agrees to loan Garrett $25,000 to buy a car, but only if Alyssa agrees to guarantee Garrett s repayment of loan Under suretyship law, Garrett is an obligor, Bank is obligee, and Alyssa is a surety (she bears the risk that Garrett will not repay his loan to Bank and that she will have to step forward and pay off the loan)
First Federal v. Arena [p. 493] First Federal held a mortgage on the Arenas land 1969: the Arenas sell the land to Richardson, who took subject to First Federal mortgage [p. 493, n. 1] After transaction, with respect to the mortgage debt: Mortgaged property = obligor First Federal = obligee Arenas = surety Suretyship Rights: Subrogation If the surety has to pay off the debt, the surety has certain rights, including the right of subrogation Restatement of Mortgages 7.6: One who fully performs an obligation of another, secured by a mortgage, becomes by subrogation the owner of the obligation and the mortgage to the extent necessary to prevent unjust enrichment. Even though the performance would otherwise discharge the obligation and the mortgage, they are preserved and the mortgage retains its priority in the hands of the subrogee. I.e., if the Arenas had to pay off the debt, they would be subrogated to First Federal s rights as mortgagee (and could foreclose that mortgage) First Federal v. Arena [p. 493] First Federal held mortgage on Arenas land 1969: Arenas sold land to Richardson, who took subject to First Federal mortgage [p. 493, n. 1] Richardson and First Federal then entered into a modification agreement Repayment term was extended from 15 years to 20 years Interest rate was increased from 6% to 7.25% Richardson assumed the debt (as modified) Richardson made payments on the modified mortgate for 6 years, then defaulted At that point, First Federal sued the Arenas to collect the remaining unpaid mortgage debt The Arenas raise a suretyship defense: We didn t consent to the modification of the loan terms, so we re discharged (i.e., we re no longer liable on the mortgage debt). Is this an appropriate argument?
Were the Arenas harmed by extension of time (extending the loan repayment term from 15 to 20 years)? Richardson had 5 more years to pay, so his monthly payments were lower (making it more likely he could make his payments) But, the principal balance would decline more slowly (due to the longer amortization period) Extension could also harm the Arenas subrogation right if the land dropped in value following modification (e.g., at time of modification, land was worth $50,000, but 6 years later, land might have dropped in value to $20,000) How could the Arenas be harmed by the increased interest rate due to the modification? Over the 6 years before Richardson defaulted, more interest would have accrued and been paid on the debt (7.25%) than would have accrued and been paid on the original loan (6%) Higher rate + longer amortization term means that principal balance would amortize less quickly (leaving higher balance than would ve existed on the original amortization schedule) Thus, after 6 years, the principal balance (for which Arenas would be liable) is higher than if modification hadn t occurred Original Mortgage Orig. Principal $36,641 Term 15 years Interest rate 6% Monthly pmt. $309.20 Balance after 6 years (when Richardson later went into default on modified loan): $25,573.70 Modified Mortgage Orig. Principal $36,641 Term 20 years Interest rate 7.25% Monthly pmt. $289.60 Balance after 6 years (when Richardson later went into default on modified loan): $30,404.24 Court holding: the unconsented-to modification resulted in a complete discharge of the Arenas (i.e., they were no longer liable on the debt, to any extent) If the actual harm to the Arenas $5,000 (the increased balance of the debt), why give them a complete discharge? Punitive rule addresses moral hazard Deters the obligee (First Federal) from taking action that could change surety s risk, w/out surety s consent
Implications for Lenders Like First Federal? Best practice: at time of modification, get Arena s consent to modification, either: Consent to be bound to loan terms as modified, or Consent to be bound to the original unmodified terms Lender could also include a provision in its original mortgage loan documents, reserving its right to enter into modification agreement with grantee, without affecting or discharging mortgagor s personal liability [note 1, p. 498] Page 494: THE MORTGAGOR COVENANTS: 6. That in the event the ownership of said property or any part thereof becomes vested in a person other than the Mortgagor, the Mortgagee may, without notice to the Mortgagor, deal with such successor or successors in interest with reference to the mortgage and the debt hereby secured in the same manner as with the Mortgagor, and may forbear to sue or may extend time for payment of the debt secured hereby, without discharging or in any way affecting the liability of the Mortgagor hereunder or upon the debt hereby secured. Restatement of Mortgages 5.3 Allows the transferor of mortgaged real estate to raise suretyship defenses (as in Arena) But 5.3 incorporates the Restatement of Suretyship, which would limit a surety s defenses (in most cases) to the actual harm that would result from a change in the mortgage terms (i.e., no full discharge merely because of the theoretical risk of harm) Problem 2 2009: Crouch buys home from Lee, who takes purchase money note in amount of $230K and mortgage 2015: Crouch sells home to Strong for $175K Strong paid no cash, but agreed to assume existing mortgage balance of $175K After 8 months, Strong discovers toxic waste and stops making payments on the note. Can Lee get a judgment against Strong on the debt?
Yes, Lee (mortgagee) can enforce debt vs. Strong It is possible that Crouch might have had a defense to payment if Lee had sued him on the debt (e.g., fraud or nondisclosure) Note 2, page 487: as assuming grantee, Strong cannot assert defenses that would have been available to Crouch Rationale: Strong agreed to pay $175K for the land by assuming existing $175K mortgage debt; if allowed to raise Crouch s defenses, she would get the land for less than she agreed to pay for it [Crawford v. Edwards, pp. 487-488]