1) INTRODUCTION TO MORTG FINANCING
a) Mortg. “Transfer by debtor-MR to a creditor-ME of a real estate interest, to be held as security for
performance of an obligation, normally the pmt of a debt evidenced by a promissory note.”
i) Decision. Decision to obtain mortg financing
ii) Application for Financing. In commercial loan, applicant will have to provide a bunch of financial
info. Less red tape in residential loans. Adjustable rates will be lower, but stand chance of going
up; fixed rates evade that risk, but lender will factor in speculation.
iii) Commitment. Lending institution makes the decision.
iv) Closing/Settlement. Parties sign a bunch of docs and lender transfers funds. Individuals can
borrow w/o collateral – whole category of loan trsxns w/ personal security (UCC 9). Here we’re
talking about loans secured by real estate – the mortg is the security for repayment of the
obligation. ME receives no ownership, but merely an interest.
v) Due Day (“Law Day”). Date when loan will be paid off – may be moved forward voluntarily or
involuntarily (if there’s acceleration clause). Back in the day, if you didn’t pay by law day ME took.
vi) EOR. Equity courts imposed this – every borrower should have chance to reply – after all, no
reason for lender to be so harsh as to seize immediately. Can’t clog EOR or give it up.
vii) Foreclosure. Foreclosing EOR – either strict (EOR gone; defeasible fee becomes FSA in hands of
ME) or sale. Mortg may require judicial sale or power of sale (often via deed of trust, allowing ME
to bid). About ½ states have stat. foreclosure (agriculture states). Then deficiency jdgmt.
c) Not Necessarily for Land Purch. Not always related to sale/purch of prop – may mortg prop to secure
repayment of loan to send kids to college.
d) History of Mortgage Financing.
i) Until 1930s, most mortgs were “balloon-note”– short-term (3-5 yrs) and borrowers made only int
pmts until due – then borrower had enough to repay principal or asked for renewal.
ii) Depression. Lenders forced to demand full pmt & foreclose on prop when MRs couldn’t pay –
lenders developed amortized mortg loan system under which MRs paid off over # of years by
monthly pmts toward principal & interest payments. No principal lump sum ever due.
iii) Extremely high rates & scarcity of mortg funds in ‘80s led many buyers & sellers to seek
alternative or “creative” financing techniques which did not require a new loan.
e) Basics of Amortized Loans. Monthly payment set up so that only a portion goes to interest; more
interest at beginning bc calculated on larger unpaid principal. Principal declines more rapidly later into
mortg. Factors that matter: principal, rate, repayment period.
f) Alternative or “Creative” Financing Techniques. Ways to finance home sale w/o new loan.
i) All cash sale. Buyer pays all cash to seller (may have it from savings or gifts). Most common.
ii) Assumption or Taking Subj to Existing Mortg. Buyer takes over seller’s existing mortg and pays
cash equal to diff bw sales price of prop & balance on existing loan. Buyer takes over by signing
assumption agreement or merely by taking “subject to” the loan w/o express promise to pay.
iii) Seller Financing. Only 1 debt involved: buyer enters mortg loan or installment K w/ seller for all or
big portion of purch price. Debt bears interest & requires regular installments (similar to
institutional loan). Seller treats obligation as investment; feasible only if seller has little need for
cash upon sale.
iv) Combo of Assumption/Subject to & Seller Financing. Buyer takes over just like (2), but can’t get
enough cash to pay entire diff bw price & loan balance. Hence, buyer gives seller note secured by
2d mortg for part of diff. Reduces cash demanded by buyer.
v) Wrap-Around Financing. Trsxn bw buyer & seller structured as in (3). However, seller has
preexisting mortg financing on prop & does not pay it off at time of transfer. Instead, seller req’d to
continue making pmts on underlying inst’l loan at same time buyer makes payments on new (or
“wrap-around”) loan. Rate on wrap-around loan is often higher than on underlying loan, making
profit for seller. From seller’s p.o.v., one advantage is that seller knows immediately of any default
on the senior mortg.
2) FORECLOSURE & EOR (BASICS & HISTORY)
a) Basics. When mortg defaults, ME usually has right to “accelerate,” which has effect of making entire
debt due & payable. ME required to go through foreclosure before proceeding against MR in personal
b) Multiple Mortgs. Basic function of foreclosure: put purchaser in shoes of MR at time of execution of
mortg being foreclosed. Thus, foreclosure buyer of senior mortg takes title free & clear of junior mortgs
i) Practical point. Buyer taking at foreclosure of junior mortg will take subject to senior mortgs or
liens; thus, this will come off in the purchase price.
c) English History. CL was harsh on MR: ME used possession + right to collect rents as method to get
return since taking of interest considered usurious & unlawful. (Custom developed to leave MR in
possession, although ME retained right to possession.) Due date was “law day”; if for any reason
payment not made MR forfeited any interest and ME’s defeasible fee converted to FSA.
d) Intervention of Equity. Intervened to aid MR who had equitable grounds for late pmt.
i) EOR. Became used so frequently that MR could redeem land if she tendered principal & interest
w/i reasonable time. Reflected view that ME’s int was only security.
ii) Right to Foreclose. At first, EOR created problem for ME who could not be reasonably assured
MR would not sue in equity to redeem. Thus gave right to ME to foreclose.
(1) Strict Foreclosure. Used at first. No sale; land forfeited to ME after order from court to MR to
e) American Foreclosure.
i) Foreclosure. Strict foreclosure still used in a few JXs, but most now have a sale of premises.
(1) Judicial. Most common. Public sale results after full judicial proceeding in which all
interested persons must be made parties.
(2) Power of Sale. After varying types/degrees of notice to parties, prop sold at public sale by
public official (sheriff), ME, or some other 3d party.
ii) EOR. Can’t be lost by MR unless valid foreclosure. Prohibition against clogging MR’s EOR.
iii) Statutory Redemption. About 20 states. Created in part to pressure ME to bid value of prop at
sale, at least up to amount of mortg debt (thus, redemption price usually sales price and not debt
amount). Period begins after foreclosure (after EOR cut off). Varies by state; MR, & sometimes
holders of subordinate ints, may redeem for some fixed period after sale.
iv) Deed of Trust as Mortg Variant. Involves conveyance of prop to 3d person (lender’s lawyer) in
trust to hold as security for payment of debt to lender-noteholder whose role is analogous ME.
Almost always includes power of sale in trustee to be exercised after default at request of lender-
v) Mortg Substitutes & Clogging EOR. EOR is undesirable to ME –in event of default, would rather
have power to assert and keep FSA title to realty. Thus, many try to get around it.
3) USE OF MORTG SUBSTITUTES & CLOGS ON EOR.
a) Clogging MR’s EOR.
i) Rule. EOR can’t be clogged and MR can’t cut off own right to redeem. Can’t K it away. ME can’t
take option to buy prop for fixed price contemporaneously. EOR recognizes right of MR in default
to insist she be deprived of mortg’d real estate only by foreclosure that tests its value at a public
ii) Anti-Clogging Stats. NY stat says clogging provision is “not unenforceable” as long as not tied to
default. CA/VA similar, but never allows clogging on residential prop w/ 4 or fewer units. Under
Rest., option is enforceable unless tied to default.
iii) Deed in Escrow as a Clog. Sometimes, along w/ trad’l mortg, MR delivers to ME or escrow agent
deed to mortg’d real estate to be recorded in event of default. This is a clog on EOR.
iv) Exception for Certain Options. A few cases uphold enforceability of options against clogging
attacks where option in Q is not being used to circumvent foreclosure.
v) Exception for subsequent conveyance. Clogging doctrine generally NA to trsxns subsequent to
execution of mortg. Ex: courts routinely uphold “deed in lieu of foreclosure,” which amounts to
conveyance of EOR to ME when MR threatened w/ foreclosure.
b) Deeds to Disguise Mortgs.
i) Purpose. Creditors use to avoid “grantor’s” EOR. Other advs: (1) right to possession of land before
default, (2) right to possession of chattels severed from land by debtor or 3d parties, (3) prevent
debtor from encumbering land w/ further mortgs or jdgmt liens, (4) obtain equity int in prop and
thus can structure as NR loan w/ share of profits; (5) avoid usury law by casting extra cost as
increase in repurchase price, rather than interest.
ii) Devices. Creditors use 2 devices to create real prop security w/o appearing to enter security trsxn.
(1) Absolute deed. Creditor requires debtor to grant land by absolute deed under oral agreement
or tacit understanding that she’ll reconvey only if debtor pays debt when due.
(2) Absolute deed + something. Creditor obtains from debtor absolute deed to prop & executes
sort of written agreement to reconvey prop to debtor upon receiving pmt. Written agreement
may take form of (1) option to repurch, (2) uncond’l K obligating grantee to reconvey &
grantor to repurch, or (3) leaseback to grantor w/ option to repurch at or before end of lease
c) Equitable Mortg Instead of Deed.
i) Equitable Mortg. If purpose of deed is security, treated as equitable mortg even though parties
may’ve agreed debtor s/n/h right to redeem.
(1) BoP. Typically clear & convincing evidence to establish mortg. In conditional sale cases,
however, some require higher (preponderance) bc less disturbance grantee’s expectations
and less contradiction w/ deed in absolute deed trsxns.
(2) Examples of Finding EM.
(a) Absolute Deed. Deed from grantor appears to show prop sold for advance money (prop
already sold) to be used for child’s tuition. Parol evidence used. Flack v. McClure.
(b) Conditional Sale. Deed to grantee, and 2d doc conferring to grantor obligation/option to
purch prop described in deed. Clear from 2d writing that grantor has right to reacquire.
Sannerud v. Brantz (deed to broker for $ to keep prop from being foreclosed).
(c) Negative Pledge. Where MR agrees not to encumber prop until specified loan repaid.
Usually cannot show intent to create security interest. If broken, grantee can declare
loan due, but CANNOT foreclose. (Equitable Trust v. Imbesi)
ii) Lenders Don’t Want EMs Imposed. Not as good as regular mortgs bc no explicit terms (i.e.,
remedy language, restrictions on what owner must do to protect prop, etc). Lender better off
structuring trsxn as mortg than having EM imposed.
iii) Factors in Imposing EM. None are dispositive, but existence of debt is important.
(1) Intent that Conveyance Serve as Security for that Debt/Obligation. Crucial Q: did parties
intend deed to stand as security for debt. Even if parties agree “this is not a mortg, default
will result in forfeiture,” still ask: was intent to create security for a loan? Shown where
there’s a contemporaneous agreement to repurchase.
(2) Existence of Debt or Obligation to Grantee. Fact that loan is made for future debt or that
there was no fixed time for repayment s/n/h affect. Right to redeem after default is
inseparable incident of mortg rltnsp – can’t be K’d around.
(a) Easy case. Where grantor is indebted to grantee at conveyance and grantee retains
note evidencing indebtedness. Then indebtedness was not satisfied by conveyance
and, until the contrary is shown, it’s presumed that mortg was intended.
(3) Relationship of Parties & Prior Negotiation. Did they contemplated mere security for debt
(4) Legal Assistance.
(5) Relative BP/Circs. Oftentimes w/ EMs, borrower is acceding bc she needs money and can’t
obtain on more favorable terms. Was there distress?
(6) Adequacy of Consideration. If consideration grossly inadequate, mortg strongly indicated.
(7) Who Retained Possession of Prop. If grantor of deed remains in possession suggests deed
was conveyed for purpose other than sale of property, i.e., security.
4) INSTALLMENT LAND K
a) Basics. Most common sub for deed as land financing or mortg. Same function as purch $ mortg:
financing by seller of unpaid portion of purch price. Desirable bc easy to terminate purchaser’s int upon
default. Also low down-pmt, low financing costs, and seller spreads tax burden over life of K. Often
used w/ vendees whose credit might preclude them from desirable institutional loans.
b) Mechanics. Vendee has possession & agrees to make installment pmts of principal & interest until
principal paid off. Vendor retains title until final pmt, after which she has duty to execute deed to land.
Vendee pays taxes, maintains insurance, & keeps prems in good repair.
c) Difference bw ILK & Mortg. No EOR under ILK; legal title still w/ vendor (seller). ILK’s have forfeiture,
upon which buyer’s ints are terminated and they lose money paid. Allowable bc based on K law.
d) Approaches. (1) Some treat as pure ILCs; (2) some look to equity; have there been substantial
payments; (3) some treat it like an EM, and require foreclosure and EOR.
e) Default. Note that forfeiture isn’t desirable to seller if the real estate is now worth less than K price.
i) Remedies for Vendor. If vendee (buyer) defaults, vendor may rescind K or sue. Once forfeiture is
accomplished, vendor may not seek to recover on the K – it’s over. Either ask for SP or go for
forfeiture – not both. Summit House v. Gershman. Possible actions:
(1) Installments Due w/ Interest.
(2) SP of K. Vendors are highly successful here, especially in earnest money contracts.
(3) Dams for Breach. Typically, diff bw K price balance and MV at breach. But this is tough bc
vendee will have to be off the land – and tough to get forfeiture, so must be abandoned.
(4) Foreclose Vendee’s Rights. Courts sometimes give this option to vendor. Some courts do it
by judicial sale. Economically similar to SP bc vendor obtains jdgmt for K balance.
(5) Quiet Title. K is canceled and title to the land is quieted in the vendor. However, purchaser
has redemption period set by court to tender the balance. Note that if there’s huge excess of
value over K balance, many courts will order judicial foreclosure sale.
ii) Forfeiture Clause. Included bc above remedies slow/expensive. Provide “time is of essence” &,
upon default, vendor can declare K terminated, retake possession, & retain pmts as LDs.
f) Differing Views on Enforceability of Forfeiture Clauses.
i) Strict Enforcement. Enforce clause absent unfairness which shocks conscience of court. Factors
to considered to evaluate fairness: (1) amount of $ paid; (2) period of time buyer’s possessed; (3)
MV at default compared to time of purchase.
ii) Modern Trend: Some Protection for Purchasers. Many JXs treat ILKs as mortgs.
(1) EOR approach. Some (CA) impose EOR permitting vendee to tender balance for SP.
Petersen v. Hartell (vendee who made substantial pmts or improvement has unconditional
right to rsnble opp. to complete purchase by paying balance plus dams).
(2) Judicial Sale. Some courts view trend as treating land sale Ks as mortgs (OK). If default on
ILK, require judicial sale of prop & apportionment of proceeds. Seller receives balance due
plus expenses – meets her expectations. Sebastian v. Floyd. (CA, FL)
(a) Compelling Equities Twist. Some courts (IN) refuse to do this if (a) vendee abandons
leaving vendor’s security int in danger or (b) has made only minimal pmt (look to
amount paid as well as length of pmt).
(3) Restitution for Vendee. For vendees not in EOR approach JX or unable to redeem, court
may extend to vendee right of restitution. This is a right to recoup pmts in excess of vendor’s
actual dams [actual dams: difference in K price & price at breach (or at time vendor is free to
use prop); loss of rental value while defaulting vendee in poss.; costs to repossess; cost of
resale, including commission.)
(4) Waiver. Some courts will hold that vendor’s waiver of previously late payments will avoid
effect of a FC and instead create in the vendee a right analogous to EOR.
iii) Statutory Institutionalization of the Forfeiture Remedy.
(1) Concern. Institutionalization of the forfeiture remedy may diminish possibility of equitable
relief because court may feel constrained by the statute from granting equitable relief.
(2) MN Statute. Purpose of the statute is to ameliorate the harshness of forfeiture.
(a) Requires notice of intent to terminate as well as 60 day “grace period” in which buyer
can have K reinstated by complying with conditions in default, making all payments due
and owing to seller through the date payment is made, paying attorneys fees, and
paying 2% of amount in default (interest).
(b) If the buyer fails to reinstate the K w/i the grace period, the L will terminate.
(3) OK and FL Legislation. ILKs should be deemed & held mortgages, subject to rules of
foreclosure. Problem with this is ILK typically contains no acceleration clause. Unless court
is willing to employ “anticipatory repudiation” to make remaining balance due and owing,
seller will only be able to foreclose for past due installments plus interest.
g) Premises Liability of Vendors (Seller). Split in case law (???). Normally, ME isn’t liable for unsafe
conditions on prop unless she’s in possession or otherwise exercises dominion & control.
h) Encumbering Vendor’s Interest. ILK purchaser builds equity by making pmts – thus, she has interest
which may be encumbered (used as collateral). If she mortgs and defaults, what’s the right of ME?
i) Title Holder Must Notify ME She Has Actual Notice. Before terminating vendee’s interest, vendor
must notify vendee’s ME if she has actual notice. Weird bc ME knew they were taking land w/ sec
int. This is to protect ME. (In some JXs, constructive notice is enough & recording suffices.)
ii) ME’s Rights After Default. In a few states, ME can pay balance on K and take the land. In other
states either: (1) ME can pay off seller and be subrogated to their rights to take collect OR (2) can
force sale of prop to get their $.
i) Encumbering Seller’s Interest. Seller can execute, as security for loan, both an assignment of right to
receive payments and mortgage of legal title. Holders of these types of interests must file under UCC 9
to ensure priority over seller’s creditors – recording is not enough.
5) PRIOR TO FORECLOSURE
a) Theories of Title.
i) Title Theory. Favors ME. ME got right of possession at time K was executed. Title remains in ME
until satisfaction or foreclosure. Rooted in CL where ME took possession & access to rent – in
place of collecting interest (usury). If you had title you could take possession – K’d away usually.
ii) Intermediate Theory. Legal & equitable title remain in MR until default, at which time legal title
passes to ME – no right of possession until then.
iii) Lien Theory. Maj of JXs. Favors MR. Mortg is a lien – ME has ONLY security int, no right of entry
(unless in K). ME gets possession only after foreclosure. Legal & equitable title in MR until f.c.
iv) Practical Significance. Only matters w/ possession upon default. In all JXs, MR owns in FSA.
b) ME in Possession. May be liable in tort for condition of premises or injuries thereon. Responsible for
maintenance & preservation of property and has duty to protect against vandalism. Must use rents to
pay off debt of MR. Does not have to expend more than rent & profits he receives. Does not have to
prevent or make good ordinary wear & tear. Due to these duties, MEs try to avoid it and get rents other
ways, e.g., receiverships.
c) Assignments. Agreement under which MR assigns or mortgages rents as additional security for mortg
loan. Provisional remedy for lender when MR is in default prior to foreclosure. Good bc ME gets cash.
Nowadays, every JX recognizes assignment of rent (used to be problematic in lien theory JXs).
i) When Does Assignment Take Effect bw Parties.
(1) Majority Execution. This is the newer approach. Most courts say upon execution.
(a) Absolute Assignment. New rule used where ME received absolute assignment of rents
rather than security int. Must be clear evidence. Most courts see as security
(2) CL Action. Must record & engage in activity – take affirmative step to start collecting rents.
ii) When is it Perfected Against 3d Parties.
(1) Recording. Recording mortg containing assignment gives ME rights superior to subsequent
interests. (Millette: avoided result where jdgmt creditor would be superior bc she can perfect
any time whereas lien on rents must wait.)
(2) CL Additional Action. This is the old CL approach.
(3) Practical Note. Many MEs record in records AND under UCC 9. “Belt & suspenders”
approach in case rents are considered personalty bc just money. BEST TO FILE BOTH.
iii) Collection Commencement. Most require extra step before ME start collecting rents; usually
iv) Uniform Act. Only a couple states have considered it. Acknowledges that under lien theory (unlike
title theory) mortg did not automatically create assignment of rents. Act says the mortg is
automatically an assignment of security int in the rents. Perfected upon recording.
v) ME in Possession. MEs often worry they’ll become ME in possession simply by enforcing
assignment of rents provision. This would make them liable for premises.
(1) Rest. Mere collection pursuant to assignment does not constitute ME in possession.
(2) Courts. Look to factors to determine whether ME exercised possession & control: paying
bills, collecting rent, making repairs, hiring, and making managerial decisions.
d) Receiverships. Judicial appointment of 3d party to take possession of mortgaged prop, to repair,
preserve, or collect rent. Better than ME in Possession bc no accounting duties, no K/tort liability, jr.
leases continue. Also, if no Ts then assignment of rents does nothing, whereas receiver can try to
reestablish cash flow. Finally, ME can seek receiver for rents/profits in f.c.; important in lien theory
states for that & for ejectment (tough to get).
i) Agent of Court. Receiver gets paid, but is an officer of the court and is not liable, not an agent of
requesting party. In case where D-MR refused receiver’s requests as value declined and ME was
not an ME in Posession, D bore loss via a larger deficiency judgment.
ii) Grounds for Appointment.
(1) Automatic in Min of States. Automatic in some JXs.
(2) Require Equitable Circs. In other states, must show equitable reason, i.e., inadequate
security, insolvency or financial status of MR, waste (split: is failure to pay taxes waste?),
(3) Rest. Requires (1) default; (2) inadequate value to fulfill obligation; & (3) waste (can include
failure to pay insurance premiums, prop taxes, or improper taking of rents.)
iii) Receiver’s Powers. Preserve ME’s security by taking possession & collecting rents & profits
(1) Collecting Rent from Jr Lessees. Even w/o assignment – receiver acts for court. Often to
take money and apply toward foreclosure.
(a) Disaffirmance of Leases. Generally can’t unless it contravenes provision of mortg or
was made while MR was in default and is not commercially reasonable.
(2) Collecting Rent from MR in Residence. Difficult, but allowed in some JXs
(3) Operating MR’s Business. Usually only if property is an apartment bldg.
(4) Competing Receivers. Receiver appointed on behalf of jr-ME acts on behalf of that ME –
does not have to apply proceeds toward senior liens.
i) Basics. “Waste” is unreasonable conduct by owner of possessory estate that results in physical
damage to the real estate and substantial diminution in value of the estate in which others have an
interest. Waste can reduce prop value, which can adversely affect ME’s security int. ME may go
after grantee if they assume the mortg.
ii) Types of Waste.
(1) Active or Voluntary. Affirmative act which results in destruction or alteration of prop.
(2) Passive or Permissive. Results from neg or omission to do that which would prevent inj.
Some courts say failure to pay prop taxes – unclear.
iii) Grantee of MR Can Be Liable for Waste. Even if GE doesn’t assume, covenant for waste may run
w/ land – being sued on relationship w/ prop. In Prudential, non-assuming GE was in possession
of prop and committed acts leading to diminution in prop value. Some courts say allowed to
recover amount of waste, even if more than the debt.
iv) NR Loans. MR is not liable – may bar action for waste – must look to the loan (some carve out
exception where even if MR isn’t liable for debt, she is liable for waste).
(1) Dams. Under Restatement, dams can’t exceed least of (i) actual harm, (ii) mortg debt amt (or
unpaid deficiency), or (iii) amount by which ME’s sec int has been impaired.
(a) Amount of Impairment to ME’s Sec Int. Rest says = L/V ratio drips below scheduled
level. Some take hard-nosed approach: no impairment unless reduces value below amt
required to secure debt.
(2) Foreclosure. May be ordered unless waste was by 3d party w/o consent of MR.
(3) Injunction. Possible in all states if ME’s security int is impaired (margin bw land value & mortg
is less than prudent investors require). [Ex: Mtgd land = 11; mtg = 8; waste =
f) ME Liability for Environmental Problems.
i) Basics. Generally, ME not responsible to 3d parties (private or governmental) for condition of
mortgaged prop or injuries on it. Lender only assumes such responsibilities by taking possession.
CERCLA & similar state legislation has increased potential for ME liability, but not much.
ii) CERCLA. Imposes L for cleaning costs for hazardous waste on prop owners & operators when
dumping occurred. This is strict L, and it’s joint and several L. Has exception however ME who
“holds indicia of ownership primarily to protect security interest.”
(1) Two concerns. (1) Does lender’s “participation in management” destroy its exemption? (2)
Does lender’s purchase of property at foreclosure destroy its exemption?
(2) Practical Point. MEs don’t get off scot-free: bought dirty site, next purchaser will have to
clean – this reduces land value.
(3) Cleanup Costs. Not only a lien against prop, but there’s a super lien. That is, lien for cleaning
costs takes priority most liens on the prop. In particular, they take priority over mortgages.
(4) “Owner & Operator” Exclusion. Normally, you’d say lender is not owner or operator thus no
CERCLA liability. But exemption lost if it participates in management – some courts defined
this broadly (capacity to influence management – Fleet Factors) while others were more ME-
friendly (exemption applies if merely trying to protect security interest –Mirabile)
(5) Practical Note. Almost every mortg requires MR to comply with all applicable laws, including
CERCLA. Means MR’s in default of mortgage as soon as it violates CERCLA. Lender can
threaten to make MR pay off whole loan.
iii) Cong’s ’96 Statute. Basically codifies ‘92 Reg, which was shot down as overextension of EPA’s
authority. ME liable under CERCLA only if “actually participating in management.” Extends
exemption to protect ME after it acquires ownership through f.c. purchase, as long as it attempts
to sell at “earliest practicable, commercially reasonable time.” So long as ME is taking steps to
dispose of prop, it may “maintain business activities” and otherwise operate the facility.
(1) Prior to making loan, ME requires inspection of premises? No L – any action or non-action
before security interest is created doesn’t count as management.
(2) ME requires borrower to comply with all laws before making loan? Same thing. But what
about after? Same.
(3) ME finds something bad on land, tells borrower to clean it? Not management.
(4) ME reviews borrower’s financials after making loan? Not participation in management.
(5) ME inspects? No. Inspections & monitoring won’t constitute participation in mgt.
(6) ME exercises decision-making authority over environmental compliance? Seems like lender
could be liable. Leg talks about exercising decision-making authority.
(7) ME takes over day to day management of company? Participating in management, even if
they’re not specifically in charge of environmental decisions.
(8) After default, what if ME renegotiates loan? No L.
(9) ME becomes owner but doesn’t seek to resell for 18 months? If over 12 month period, out of
safe harbor, but could be safe if reason other than wanting to be owner.
iv) Consequences to ME. CERCLA has strict L unless you fit into stat (unlike CL). To minimize
potential L, may want to get environmental insurance or receivership. Can foreclose, but don’t
acquire title – acquire from MR on its personal obligation. Really overprotects ME (could be liable
for repairs after purchasing at FC but not for environmental – whack).
v) Advising MEs Who Fear L. Inspect & reserve right to inspect during loan. If you get to FC, appoint
receiver. Put provisions in doc. Get environmental insurance. Remember, 2 options for lender: FC
on mortg or sue on note. If borrower is solvent, forget mortg & sue on note (debt). Edwards.
g) Insurance & Real Est Taxes.
i) Overview. Insurable interest of MR is value of premises; insurable int of ME is mortg debt. Usually
ME requires MR to carry casualty insurance insuring interests of both parties. ME may not collect
on proceeds of casualty insurance and on full debt – unjust enrichment. ME limited in recovery to
amount of debt.
ii) 2 Forms of Casualty Insurance Policies.
(1) Standard Mortgage Policy. Independent agreement bw insurer & ME that ensures ME can
recover no matter what MR has done. Allows lender to recover even if borrower engaged in
acts that bar MR’s recovery. If insurer pays mortg debt in full, it becomes subrogated to the
debt & mortg, and can enforce them against MR. If MR fails to pay premium, insurer must
give notice to ME before canceling policy.
(2) Open Loss Payable Policy. Policy merely identifies who is to collect on proceeds, and
indemnity of the ME is subject to the risk of every act of the MR.
iii) Approaches on Application of Proceeds. Some say ME can recover proceeds regardless of value
of remaining security. Some say MR may recover in order to rebuild damaged prop. Mortg should
contain covenant requiring MR to carry insurance (gives ME right to proceeds to extent casualty
impairs ME’s security).
(1) Majority. ME has option of applying proceeds up to full amount of debt or to rebuilding, if
there’s no mortgage provision to contrary. Otherwise, too much litigation over things like
repair costs and FMV.
(2) Minority. ME is entitled to recover proceeds only to the extent its security has been impaired
by loss/damage. Often measured by restoring to scheduled L-V ratio: take loan to initial
value; ME gets proceeds to restore to that. Mixed bag on what to do w/ the rest.
(a) MR can recover in order to rebuild damaged prop. Prevents MR from losing benefit of
the loan that was bargained for. Demanding proceeds acts as acceleration of debt.
(b) In California, proceeds may be used to rebuild even in face of specific mortg language
giving ME option of compelling prepayment of debt. Must be for rebuild though.
(3) Restatement. If rebuilding is feasible (adequate time, & real estate value will equal or exceed
value at time mortg made) then ME holds funds subject to a duty to apply them. Lender gets
only up to extent security has been impaired (restore to scheduled L-V). Parties may agree
otherwise, but subj to K arguments of unconscionability & good faith/fair dealing.
iv) Full Credit Bid at FC. If ME makes full credit bid at FC, they bid full amount of mortg so there’s no
mortgage anymore – no basis for ME to collect anything! (Contrast: if there’s deficiency, then MR
still has obligation and thus an insurable interest.)
h) Disposition of Eminent Domain Awards.
i) Full Taking. ME is entitled to entire award, or up to mortg debt.
ii) Partial Taking.
(1) Maj. Same – ME may take entire award up to debt balance.
(2) Newer view. ME may recover only enough to compensate for impairment.
(3) FNMA Form. ME may take = (proceeds) * (pre-taking debt / pre-taking FMV)
i) Escrow Accounts for Taxes & Insurance.
i) Imposing Duty to Pay Taxes. Important to ME bc if MR doesn’t pay, then both could lose their
interests. Thus, many ME’s use clauses allowing acceleration of debt for failure to pay taxes.
ii) Use of Escrow Account. Many MEs demand set-up of escrow accounts. MR pays 1/12 of annual
taxes & insurance premiums each month in; ME will make the payments due out. At creation of an
the account, lender may require borrower put front-end payment and a cushion in the account
iii) Function of Escrow Accounts. Ensures MR will save enough to pay; also gives ME early warning
system – as soon as MR misses a payment, ME is aware and can protect itself.
iv) Escrow Interest. Escrow accounts can be used for revenue for loan servicers – invest. Big source
of income. Courts typically do not entitle MR to interest proceeds, although a few state legs have.
6) TRANSFER AND DISCHARGE
a) Transfer of MR’s Interest.
i) What Can MR Transfer. MR is free to convey – anything to the contrary is void as an illegal
restraint on alienation. MR can transfer (1) property interest (title) or (2) possession.
ii) What Happens to Existing Mortg.
(1) Mortg May Terminate. Refinancing: GE finds new financing and MR deeds prop to GE after
paying it off and clearing any encumbrances.
(2) Mortg May Survive. GE pays MR value of their equity – takes property subject to mortgage,
and has option to assume. No matter what, original MR remains liable on mortg as a surety
(unless MR is released from liability). The differences are as to GE’s responsibility.
iii) Rights & Obligations of Parties When Mortg Survives Conveyance.
(1) Assumption. GE takes land encumbered by mortgage & assumes liability for the debt. In
order for assumption to be acceptable, there needs to be express promise to make payments
and perform all covenants on note & mortgage. Courts will not imply assumption from fact
that prop is encumbered or that purchaser paid price bw mortgage debt and price. Purchaser
becomes principal and, upon default, lender may foreclose & sue her.
(a) GE’s Rights & Obligations. MR or ME can sue to enforce assumption & get deficiency
against GE or K price w/o foreclosing.
(b) MR’s Rights & Obligations. GE assumption does NOT relieve MR of liability. Subject to
deficiency after foreclosure or direct suit for debt. MR may sue for value of note. MR
may sue for value of note (subrogating right to sue to ME0, foreclose against GE, or sue
GE for breach of K and apply $ to satisfy ME.
(c) Successive Assumption Conveyances/Break in Chain. Each GE is personally liable on
mortgage debt, with last assuming most responsibility. If chain is broken by “subject to”
conveyance, JXs split: (1) ME is seen as 3d party beneficiary, and subsequent GEs are
liable; (2) in derivative theory JXs, ME has no claim on GE of “subject to” conveyance.
(d) Termination or Modification of Assumption K. If ME is seen as 3d party beneficiary,
subsequent GEs are liable. If derivative theory JX, ME has no claim on GE unless ME
has already foreclosed on prop prior to termination/modification.
(2) Taking Subject To. Purchaser may purchase the prop subject to the existing loan.
(a) GE’s Rights & Obligations. GE does not assume personal responsibility on mortg. ME
may foreclose in event of default, but can only go against MR for deficiency. GE has no
responsibility on debt. MR may try to give deed to GE; GE could pay off to keep prop.
(b) MR’s Rights & Obligations. MR remains liable, unless released by ME. If there’s default,
ME may either sue for value of note (subrogating right to foreclose to MR) or foreclose
(GE has no liability for deficiency).
(3) MR as Surety. No matter what, MR remains surety on prop. As a surety, MR has 3 forms of
recourse against purchaser who assumes mortg debt.
(a) Subrogation. If MR pays debt in full, MR-surety can step into ME’s shoes and foreclose
mortgage, provided ME has not already done so.
(b) Reimbursement. MR is entitled to indemnity from assuming purchaser if MR has paid all
or part of mortgage debt.
(c) Exoneration. If assuming purchaser doesn’t make payments when due, MR can obtain
court order compelling purchaser to pay.
(d) Surety Defense. MR-surety can be discharged from L when acts of ME, which are
binding on MR in asserting recourse against GE, have changed deal MR-surety
originally made in a way that impairs MR-surety’s position. Even if there’s a reservation
of rights clause (allows ME to deal freely w/ anyone who buys prop), deals must not
exceed scope of consent given. Arena. MR-surety released partially (w/h/b completely if
it was an assumption). Rest. says release is to the extent the modification harms MR.
b) Restrictions on Sale by MR: Due on Sale Clause.
i) Due on Sale Clause. Mortgage provision that affords ME the right to accelerate mortgage debt
and foreclose if mortgaged property is transferred (sale, 2d mortg, lease, easement).
ii) Two Functions: (1) Protects ME against transfers that endanger mortgage security or increase risk
of default. (2) Enables ME to recall below-market-interest-rate loans during periods of rising rates.
iii) No Restraint on Free Alienation. This does not allow ME to stop transfer, just accelerate debts on
the underlying mortgage. Courts grappled w/ enforcing – then fed gov stepped in.
(1) Auto Enforcement. Some courts provided DOS clauses are per se reasonable, absent a
showing that ME engaged in unconscionable conduct.
(2) Impairment of Security. Others provided ME has burden of establishing clause is reasonable
bc transfer would result in security impairment or increased risk of default.
(3) Fed Gov Resolution St. Germain Act. Legislation provides for free enforcement of DOS
clauses. Preempts state restrictions on DOS clauses, thereby making such clauses generally
enforceable. Act does not apply to loans made by private banks. However, Act enumerates
several types of transfers insulated from acceleration: jr. mortgs, transfers incident to divorce,
to certain relatives, and leases for 3 years or less with no option to purchase. Also, NO PRE-
PAYMENT PENALTIES ALLOWED!!
iv) Transfer w/o Telling ME. Most DOS clauses contain no express covenant on MR to disclose to ME
that transfer is taking place. As such, MRs are tempted (and advised) to transfer w/o telling. But if
ME discovers transfer’s been concealed, it can accelerate if it acts w/i rsnble time of discovery.
c) Transfer of ME’s Interest.
i) What Can ME Transfer. Right to foreclose & recover deficiency. Also, may transfer the note.
Governed by commercial and K law.
ii) Situations When ME Transfers.
(1) Secondary Sale. ME sells loan to another investor, transferring the note & mortgage to AE.
(2) Collateral Assignment. ME borrows $ from another lender and pledges the loan as security
for repayment of that money. Parties expect when new debt is repaid, mortg will be returned.
(3) Securitization of Loan: ME pools this loan with others, and then sells securities to public that
are collateralized by the pool of loans.
(a) Sell Participations. Gives each investor partial interest (TIC) thus entitling each to a pro-
rata portion of payments made by MRs of the underlying loans, less fees to originator.
(b) Sale of Multiclass Mortg-Backed Secs. Sell to issuer who breaks down mortgs into diff
classes w/ principal and interest coming from various sources. Each investor in the
security receives some combo of principal & interest payments covered by the
payments made by the MRs of the underlying loans.Complex. Big on Wall St.
(c) Sell to Investor For Pass-Through Secs. Security being sold not mortg share, but it is
backed by pool of mortgs & payment comes from there. GNMA does this w/ FHA loans.
iii) Holder in Due Course. Point of being HDC is to be able to collect w/o regard to claims MR had
against original ME. HDCs, are free from “personal” defenses, but remain subject to “real” defs. If
not a HDC, then the AE is subject to any defs that would be available to obligor against AR.
(1) HDC Requirements. (1) Underlying obligation is negotiable; (2) obligation transferred to AE
by negotiation; & (3) w/o notice of defects or defense.
(a) Negotiable. Must have maker’s unconditional promise to pay fixed amount on demand
or at definite time. Must be payable to “order” or “bearer.” Should not incorp by ref any
other terms. Ruled by UCC 3. Adjustable rate loan would not comport.
(b) Transferred. The actual instrument must be delivered. If it’s payable to a specific
person, it must be indorsed on the instrument (or attached thereto). Pay to bearer.
(c) Notice. Actual, delivered, or should know due to facts and circs.
(2) Real Defs. Duress, lack of legal capacity, & illegality of transaction which, under other law,
nullifies obligation of obligor; fraud that induced obligor to sign w/o opportunity to learn terms;
discharge of obligor in insolvency proceedings.
(3) Personal Defenses. Failure or lack of consideration, breach of warranty, unconscionability,
and a garden variety of fraud.
(4) Exception – Close Connectedness. Some courts don’t allow HDC status in situations where
purchaser of note is too closely connected to transferor.
iv) Payment Rule. One paying note must demand production of it upon payment or risk having to pay
again to AE bc payment is good only if it’s made to note-holder. Purpose is to encourage MR to
require ME to prove possession of note before paying.
(1) Exception: Non-Negotiable Notes. Restatement provides MR may continue to pay original
ME until MR receives notice of assignment. Transferee has notice of these payments, as
does anyone whose rights stem from transferee.
(2) Exception: Authority to Collect. If AR-ME is given authority to collect, then may pay her.
v) Servicing. Servicing of loan includes collecting/accounting for payments, maintaining escrow to
pay taxes & insurance, and dealing w/ defaults or foreclosures. Function of ME & servicers are
often split. Servicer earns servicing fee and interest on balance of escrow account it maintains.
Servicing can be freely transferred, but several states now require adequate notice to the
vi) Recordation of Mortgage Assignments.
(1) Validity of Assignment bw Parties. Recordation is unnecessary as bw parties to an
(2) Failure to Record as Excusing MR’s Default. Recording acts are intended to protect
subsequent purchasers of the land or the mortgage – MR is neither. Failure to record
assignment of note is not a defense to MR payment of loan.
(3) Recording Giving Notice of Assignment to MR. If note is negotiated to AE, under “payment
rule” MR is bound to discover by demanding to see note before each payment. Recording
assignment doesn’t add anything. If note is non-negotiable, recording is not itself notice of
assignment to MR.
(4) Recording as Notice to GE of MR. If note is non-negotiable, so that it’s relevant to determine
whether GE has notice of assignment, recordation is held to give GE notice.
(5) Failure to Record as Facilitating Wrongful Release by ME. This is why AEs should record.
ME could assign to non-recording AE , and then connive w/ MR to sell off the mortgaged
prop to GE. Prop looks unencumbered, and proceeds may be split bw MR & ME.
(6) Effect of Recording on Successive Conflicting Assignments by ME. If ME makes 2 conflicting
assignments, first to AE1 and then to AE2, first Q is whether note is negotiable: if note is
negotiable then whichever party takes physical possession of the note will prevail, despite
recording. If the note is non-negotiable, the state’s recording act governs.
vii) Collateral Assignment of Mortgages. Collateral assignment is where a loan is pledged by ME as
collateral for ANOTHER loan. Servicing it not common w/ this type of assignment (compare to
outright assignment, where servicing acts as an incentive). To foreclose on a pledged mortgage,
banker-AE may: (1) sell loan on secondary mortgage market or (2) notify MR to make payments
directly to him.
viii) Article 9. Doesn’t apply to real property, but does apply to assignments of notes & mortgs bc
“property” which is the subject of security is the set of rights created by the note & mortgage. To
perfect under Art. 9, either (1) take possession of the note or (2) record UCC-1 with SoS.
Perfection gives party priority over subsequent purchasers, assignees, and liens.
ix) Mortgage Participations. Lead Lender originates mortgage loan & sells fractional interests to
investors. Lead retains original note & mortgage and sells participation certificates to other
investors. Participation certificates are governed by the Participation Agreement.
(1) Purpose of Participations. Used (1) to limit exposure and (2) to comply w/ gov regs capping
how much $ you can lend out.
(2) Priority in Foreclosure. Most courts grant pro-rata priority to foreclosure proceeds & any
collectible deficiency. Absent guarantee of payment to investors, investors have no priority
vis-à-vis lead lender. Participation agreement may establish priorities; this is often done
(3) Bankruptcy. Participations are not subject to challenge by bankruptcy trustees, but loans are.
If participation agreement is disguised as a loan, it is subject to challenge by bankruptcy
trustee. Coronet. Four factors indicating intent to create loan rather than a participation:
(a) Guarantee of repayment by lead lender to an investor;
(b) Participation lasts for a shorter or longer term than underlying obligation;
(c) Different payment arrangements bw borrower & lead lender than bw lead & investor; &
(d) Discrepancy bw interest rate due on underlying note and rate specified in the
d) Discharge of the Debt & Mortgage.
i) Basics of Payment.
(1) Payment by Primarily Responsible Party. Anyone who’s primarily responsible may pay. This
includes MRs (obviously) and even 3d parties with an interest. ME will usually provide payoff
statement upon request.
(2) Payment by Non-Primary Party. If a party who’s not primarily responsible pays (i.e., original
MR who’s transferred, jr. MR), this assigns both the obligation and mortg to the payor –
based on principle of subrogation, and the purpose is to avoid unjust enrichment. Most
common when holder of 2d mortgage learns MR has defaulted on 1st mortgage. May do this
to gain control of foreclosure or if she thinks prop value is low but on the rise.
(3) Recordable Document. Most states have formalized ME’s duty to provide a recordable
document acknowledging discharge; may be called a release or a discharge. If not complied
with, most states impose a penalty.
(4) Partial Release. Usually only a payment in full extinguishes the mortgage, but sometimes
parties will negotiate a “partial release” clause.
(1) Majority/CL Rule: Absent a prepayment provision, ME is has no obligation accept
prepayment. Justification is that if ME is forced to accept prepayment it did not bargain for,
it’d be exposed to lesser than anticipated RoR, adverse tax consequences, and added
(2) Minority/Rest. Absent prepayment provision, presumption is that MR has a right to prepay.
Courts adhering to this rule argue that such presumption doesn’t work a hardship on ME
since, in virtually all instances, she’s the drafter of the mortgage and can insert a clause
iii) Prepayment Fees. Prepayment provisions commonly permit prepayment upon MR’s payment of
an additional fee – a penalty. Court will only refuse to enforce this fee if it “shocks the conscience.”
(1) Prepayments Caused by ME’s Acceleration. Absent intentional default by MR, payment of
full balance after ME accelerates does not trigger prepayment fee. Under federal law, ME
may not impose a prepayment fee when ME declares that the loan is due pursuant to a DOS
(2) Bankruptcy Approach. Prepayment is often tendered by MR in bankruptcy. If fee is a secure
claim, lender recovers full fee. Whether it’s secured turns on whether the fee is “reasonable.”
Still, bankruptcy courts often equate these fees to liquidated dams, which are unenforceable
unless they represent a reasonable advance estimate of probable actual dams.
iv) Late Charges & Default Interest. Standard for late charges & default interest is reasonableness –
liquidated damages attack. One case said that where 5% was on the entire mortgage debt it was
unreasonable, but if only on the payment then okay. Second attack could be usury law.
v) What Obligation May be Secured by Mortg. Debt secured by mortgage must be described and of
ascertainable value. Most say the obligation need not be described in mortgage. (Still sound
practice to do so.) Obligation must also be reducible to $$ equivalent – otherwise, no way to
determine deficiency at sale and also jr. lienholder seeking to redeem would be unable to value.
i) Doctrine. When a ME’s interest & fee title coincide/meet in same person, lesser estate (the mortg)
merges into greater (the fee) and is extinguished. Intent of party in whom ints unite is important.
(1) Merger doctrine can be used as an argument that mortgage no longer exists (mortgage has
merged into the fee title and has been extinguished).
(2) But more often, merger doctrine is used as a defense to the mortgage debt (mortgage debt
has merged into the fee title and debt has been extinguished)
ii) Intent. Whether merger has occurred depends on INTENT of the parties, especially the one in who
interests unite – if it’s against THAT party best interest, it will not be considered as intended
f) Deed in Lieu of Foreclosure.
i) Overview. ME takes deed from MR in satisfaction of debt and as substitute for foreclosure. Deed-
in-lieu of foreclosure doesn’t clog EOR bc clogging applies only to agreements contemporaneous
w/ execution of original mortg, not to transactions designed to end the mortg relationship.
ii) Advantages. Avoids delay/costs of foreclosure. Also, deficiency is useless if MR is insolvent. Also,
better in achieving finality in JXs with especially long statutory redemption periods.
iii) Merger. Courts occasionally find the deed-in-lieu resulted in a merger w/ the mortg, on theory that
the deed-in-lieu merges mortgage interest and fee title, and thus mortgage is extinguished.
(1) Deed-in-lieu, however, does not operate to cut off jr. liens, and jr. lienor may argue that deed
resulted in merger such that first mortgage is extinguished, elevating jr. lien to first priority.
(2) Most courts, however, won’t apply merger in these circs bc it results in windfall for jr. lienor
w/o any action on its part. Also, courts don’t want to punish ME for accepting deed-in-lieu.
i) Background. Foreclosure process usually involves foreclosure sale. This involves the concept of
amortization. Before this came about, there were balloon payments which required borrowers pay
full balance at once. This fell out of the picture in the 1930s.
ii) Then. Lenders used acceleration clauses in the stead of balloon payments. Allowed whole loan to
become due if borrower didn’t pay installments or failed to do something required by agreement.
i) Overview. Acceleration clauses make the entire amount of the debt due upon default. Most
clauses are not self-operative, but rather require ME to perform an affirmative act. The clause
should be included in both mortgage and note.
ii) Protections. FNMA & FHLMC loans both require notice, 30 day grace period before acceleration,
and also allow MR to defeat acceleration by paying arrearages and ME’s reasonable costs until 5
days before foreclosure. Many states also require some form of notice. In other states, however,
notice is not mandatory, and ME must perform any affirmative act that evidences intent to take
advantage of acceleration clause.
iii) Enforcement. Absent bad faith or valid K claims, majority rule is to strictly enforce acceleration.
However, some look to circs – e.g., Cardozo says balance gravity of default v. gravity of hardship
on MR. Other courts choose to look more to the overall circs: in Taylor court focused on equity &
justice – if circs render acceleration clause unconscionable, then don’t foreclose!
iv) Waiver/Abandonment. Virtually all courts recognize acceleration may sometimes be defeated by
ME waiver. This can occur if ME repeatedly accepts late payments. Abandonment of acceleration
is found less often, but worth noting on exam. Many states have enacted arrearages legislation
permitting MR to defeat acceleration by curing the default that existed pre-acceleration.
v) Absence of Acceleration Clause. Problematic if MR misses payments on a long-term mortgage.
Normally, in this scenario ME may only foreclose for the amount in default. (Occasionally court will
allow acceleration based on K principle of anticipatory repudiation.) Still, however, what does
foreclosure purchaser actually get??
i) Overview. Marshaling is an equitable doctrine that may dictate order in which ME must foreclose
when mortgage covers more than one parcel of land. First rule is “two funds” rule – attempt to
avoid wiping out junior interests.
ii) Two Funds Rule. Where a SR-lienor has access to two funds for payment of debts and a JR-lienor
is confined to only one of those funds, the SR-lienor will be compelled to exhaust the fund upon
which the other creditor has no security before resorting to the additional fund. In Hansen, senior-
ME had interest in surface in minerals, while junior-ME had interest in only surface. When senior-
ME foreclosed, it was forced to sell of minerals first to satisfy the default.
d) Miscellaneous Foreclosure Methods.
i) Strict Foreclosure. Foreclosure is in court, but there’s no judicial sale. Instead MR is given a period
of time by court to pay debt. Failure to do so w/i that period results in prop vesting in ME w/o sale.
ii) Consequences. MR is liable for deficiency, but has no right to excess of value. Still used in VT and
CT. Also available sometimes to deal w/ jr. lienor who’s been omitted from judicial foreclosure suit.
iii) Constitutionality of Strict FC. It’s been challenged before, and upheld since it’s rationally related to
legitimate state interest. Court said there were purposes of strict foreclosure, such as
compensating for time and expense of foreclosure & as a quid pro quo for putting up the money.
e) Judicial Foreclosure.
i) Types of Foreclosure. Judicial foreclosure in equity accompanied w/ judicial sale is most common
foreclosure method – available in every state, and in some states it’s sole type permitted. It’s
necessary if mortg fails to contain power of sale or if there’s a serious lien priority dispute.
ii) Necessary Parties. Purpose of judicial sale is to put title to land as it stood at time of execution of
mortg being foreclosed, such that purchaser is put into shoes of MR at time mortg was executed.
(1) Junior Liens. To terminate jr. interests by foreclosure, such interests must be joined. Junior
interests are “necessary” bc failure to join them will not put title to land as it stood at time of
mortg execution. Failure to join necessary party will not terminate that party’s interest
(2) Senior Lienor. Senior lienor is responsible for joining jr. lienor, and if senior fails to do so, jr.
is not subject to the decree. Senior interests, however, are NOT terminated by foreclosure on
jr. interest. Senior lienor is not “necessary” bc senior lien existed at time jr. mortg was
executed. Senior may be joined, nonetheless, for seniority disputes or to ascertain
(3) Lessees. Senior lessees survive foreclosure, and purchaser becomes LL. Junior lessees do
not survive if they are joined – the lease is extinguished. If junior lease is not joined, majority
of courts say it’s not foreclosed. However some courts say junior lessees die even if not
iii) Omitted Parties. Foreclosure purchaser succeeds right of ME and MR as well.
(1) Rights of Omitted Owner. Redemption is not cut off bc not foreclosed, so MR can redeem by
paying debt to foreclosure purchaser, who stands as AE of the ME. Foreclosure purchaser
has no further right to redeem from or pay off MR-owner.
(2) Rights of Omitted Junior Lienor. The lienor also has an equitable redemption right, and it’s
not lost or affected if she’s omitted. Missed out on right to bid up prop. Remedies.
(a) Foreclosure: Junior lienor may foreclose his lien, resulting in judicial sale. The sale is
subj to first mortgage which is, in effect, revived for sale. Note: junior lien won’t get first
dip; the purchaser is the first lien-holder, so he gets first dip.
(b) Redemption: Junior lienor can compel assignment to him of senior lien by tendering to
foreclosure purchaser balance owed on senior lien at time of foreclosure. Junior then
holds 2 liens: a “revived” senior lien & junior lien, and may foreclose on either or both.
Tough bc it requires a lot of capital (and junior is not in place to use prop to secure
(c) Lien on Surplus. Available in some JXs. Requires that surplus is still identifiable in
hands of the original MR or of some lienor subordinate to the junior lienor.
(3) Rights of Foreclosure Purchaser. Foreclosure purchaser succeeds rights of ME and
foreclosed MR. If a junior lienor exercises either foreclosure or redemption, purchaser has 3
(a) Redemption. Purchaser can simply pay off junior lien and thereby clear the title.
(b) Re-Foreclosure. As AE of original mortg, purchaser may re-foreclose first mortg and
include junior lienor in sale. Proceeds pay off both liens, w/ surplus to reforecloser.
(c) Strict Foreclosure. Not available everywhere. It’s a court decree that junior be
foreclosed if it doesn’t pay off senior debt w/i court-determined period. Courts use this if
there’s good faith mistake on part of ME1; if prop value is about equal to senior mortg;
or where junior interest knew they weren’t being joined and said nothing.
(4) Distinguish Statutory Redemption. This comes into effect after interest is foreclosed. Only
about ½ states have it.
iv) Doctrine of Lis Pendens. Purchaser of real estate subject to litigation takes prop subject to the
final determination of litigation. It is immaterial that purchaser was not named as party or that he
has no actual knowledge of litigation (although some statutes require purchaser have notice of the
litigation in order to be bound by the doctrine). In Land Associates, junior lienors weren’t joined
and became lienholders after commencement of foreclosure suit; subject to foreclosure, but had
statutory redemption bc their interests were foreclosed.
f) Power of Sale Foreclosure.
i) Overview. In over ½ states, prevailing method is non-judicial foreclosure under a power of sale.
Results from K arrangement bw parties – not a judicial process. “Power of sale” sometimes vested
in ME, or public official such as sheriff. Often done by deed of trust (below).
(1) Drawbacks. Produces less stable title – no court supervision, and not seen as an adversary
proceeding so other parties aren’t present to raise possible defects. Finally, no judicial finality
to insulate against collateral attacks.
(2) Advantages. Designed to be cost effective & streamlined, and also to maximize price at sale.
ii) Notice. Less rigorous notice than required under judicial sale. Statutes require that some notice go
out to MR and junior interests, but it varies in form. A few states only require notice by publication;
some by mail or personal service. Some states require notice to interested and junior interests;
others require notice only to MR and prop owner; some require notice only to those who
previously recorded a request for notice. For federal gov, notice must be in writing at least 25 days
(1) HUD. Has its own system of foreclosure for HUD residential mortgs. Requires notice
published at least for 3 consecutive weeks, and notice posted on the property. Also requires
notice be sent by certified mail at least 21 days prior to sale.
iii) Power of Sale by Deed of Trust. Deed of trust is used in most “power of sale” states. Power of
sale is in trustee. MR-trustor conveys prop by deed of trust to trustee, who holds prop in trust for
ME-beneficiary until full payment of mortg debt. In the event of foreclosure, power of sale is
exercised by trustee, who holds public sale. By using deed of trust, ME is allowed to bid at the
sale (whereas if lender is conducting the sale this is generally not allowed).
(1) Role of Trustee. Trustee is to take reasonable steps to get best price – she’s trustee of both
MR and ME. Not obligated to get top-dollar, just to ensure bidding is done fairly. This role is
limited – absent unusual circs, she DOES NOT have to ensure title is free of clouds.
(2) Restriction. Trustee may not bid at sale absent express consent. Some courts scrutinize sale
closely if sale is to ME-beneficiary and trustee is closely related – may be a purch by trustee.
iv) Remedies. 3 remedies to challenge power of sale foreclosure: (1) injunction on pending
foreclosure; (2) suit in equity to set aside sale; and (3) action for dams against foreclosing ME or
(1) Void v Voidable. If sale is void, no title passes (i.e., invalid acceleration). If it’s voidable (more
often), sale can be set aside but there’s possibility that title will turn good. Title seizes to be
voidable when transferred to BFP – rights of redemption cut off (not likely to be ME).
(a) BFP. To be BFP: (1) no actual notice of defects, (2) not on reasonable notice from
recorded docs, & (3) defects not such that rsnble person at sale would’ve known. If
buyer is an experienced buyer at foreclosures, may be held to higher standard. Edry.
(2) Tender Requirement. Some courts require a MR attacking the foreclosure – that is, seeking
(1) or (2) – must tender the amount due; based on maxim: “one who seeks equity must do
(3) Damages. If already sold to BFP, cutting off EOR, many courts use difference of FMV at sale
less all liens on prop at sale. Others say amount of MR’s equity in property on date of sale.
(4) Injunction of Foreclosure. Some getting this remedy have also sought dams for expenses
such as hurting credit rating – courts frown upon this as speculative.
v) Possible Defects in Sale by Power of Sale.
(1) Two Types. Most defects based on ME’s right to foreclose or on actual foreclosure process.
(2) Inadequacy of Price. Generally, price alone is not enough to set aside sale. Must be grossly
inadequate. Some courts say if it shocks conscious & raises presumption of fraud OR
coupled w/ irregularities in sale procedure, invalidation is okay. Rest. says price must be
grossly inadequate – less than 20% of fair value, but even if above may still invalidate. Fair
value is price that would’ve resulted on date of sale from negotiation & agreement. For all
courts, if above 50% then no problem! Scrutinize closely if ME is trying to validate & seek
(3) Failure to Maximize Price for MR. Duty of foreclosing ME is to maximize price for MR. Edry
found seller did not make good faith effort to protect interest of MR bc it followed bare
statutory procedures in face of more extensive customary procedure. Sold for 45% of FMV,
seller did not ascertain FMV, & did not enhance bidding besides making own bid of mortg
balance. Display ads weren’t required, but it was customary to use them.
(4) Challenge Right of ME as Seller. Many courts hold that if power of sale is in mortgage (as
opposed to deed of trust) and ME sells and purchases, the sale is voidable.
(5) Sale by Parcel or in Bulk. Confronted with the decision, party exercising power of sale should
act in MR’s best interest. Often, selling by parcel is best bc it attracts most bidders. Some
statutes require seller to sell by parcel, but other statues give seller the discretion.
(6) Presumption Statutes. Many states have presumption statutes which enhance finality of
power of sale foreclosure & marketability of title they produce. Three cats: (1) rebuttable
presumption that terms in deed were followed and notice/procedure is fine; (2) conclusive
presumption for BFPs w/ regard to notice; and (3) conclusive presumption for BFPs with
regard to all aspects of foreclosure (extremely broad – even if ME had no right to foreclose).
vi) Constitutional Problems w/ Power of Sale. Power of sale foreclosure almost never provides for a
hearing, judicial or otherwise, prior to foreclosure.
(1) Analysis. DP clause of 5 (fed) & 14 (state) speak to gov action, so must ask if it’s gov
action. Then ask if gov action took prop interest from someone. If so, was person whose
interest was taken provided DP protections – notice & opp. to be heard. Finally, did she
waive right to DP.
(2) Notice Requirement. Must be such that it’s reasonably calculated to reach interested parties.
If you have the address, generally you must send notice. In one case, newspaper ad didn’t
meet the standard – however, could be possible if address is too tough to find. Also, just bc
notice complies w/ state statute doesn’t mean it automatically conforms to const’l
(3) Hearing. Constitution requires meaningful & timely opportunity to be heard. Doesn’t
necessarily have to be a judicial hearing, just a fair opportunity to present your side. Most
JXs don’t have such a hearing bc usually not a governmental actor – mostly private lenders.
(4) Waiver. Simply signing the mortgage cannot per se function as a waiver of DP rights. To be
effective, waiver of constitutional rights must be voluntarily, knowingly, and intelligently made.
The sophistication of the parties is an extremely important factor to consider.
(5) Federal Power of Sale Legislation. Congress says out of court foreclosures are okay w/ re. to
HUD. Notice must be mailed at least 21 days before sale, but only to owner of prop.
vii) State Actors & 14th Amdt. Five theories advanced to find state action in power of sale foreclosures.
(1) Direct Activity. State officials act directly to enforce rights arising from statute or K. Most likely
one. If sheriff conducts sale or clerk rejects/accepts bid. Arg on other side is these
employees are merely carrying out K rights bw parties – perhaps helping to complete private
action. Line is probably crossed where state employees are making decisions, being very
(2) Encouragement. State action may be found when state statutes tend to “encourage”
objectionable, but otherwise private, activity.
(3) Government Function. Where private person is functioning like a gov’t entity.
(4) Judicial Enforcement. Enforcement is akin to activity of state courts
(5) Pervasiveness Theory. State statutes are really authorizing this.
viii) Federal Actors. Q is whether entity’s actions are so closely linked to gov’t that it can be viewed as
action of fed gov’t itself. GNMA is wholly-owned & operated by fed gov’t, but courts have found
GNMA is not gov’t actor for DP purposes. GNMA acts like any ME – fed gov’t neither mandates
nor approves methods of foreclosure, nor could it since policies must comport w/ state statute.
(1) Lebron Test. (1) Does the promote gov objectives? (2) Extent to which gov retains control
over entity’s efforts to achieve its objectives. FNMA & FHLMC satisfy first prong, but fail the
(2) GNMA, FNMA, FHLMC. Remember that GNMA is the only one controlled by gov’t agency
(HUD). It’s securities are backed by FF&C. FNMA is now private, but once was under gov’t –
as such, it still has 5 of 18 board members appointed by President. FHLMC is private. Thus,
FNMA & FHLMC merely must comply with state statutes on foreclosure.
ix) Uniform Nonjudicial Foreclosure Act. Push toward uniform procedures. Goal is to bump up prices
in foreclosure sale, but unclear whether it’s going to achieve that. What it covers:
(1) Methods of Foreclosure. Could have an auction or negotiation sale. Also allows for an
appraisal, which is similar to strict foreclosure.
(2) Systems of Notice. Two-notice system – one to cure default and a second to interested
parties before foreclosure. Period in bw is a “cure period.” Foreclosure occurs 90 days later.
(3) Due Process. Notice & hearing for even for private actors. Fairness requires notice &
“informal meeting” so MR can present reasons why foreclosure s/n go forward.
(4) Omitted Parties. Puts junior interest holders in power of sale on same level as in judicial
foreclosure: no notice, not bound by sale.
(5) Redemption. Permits equitable redemption, but does does not permit statutory redemption.
(6) Title From Foreclosures. If notice of foreclosure is recorded, completion of foreclosure by
recording deed establishes compliance in favor of BFP. If not, typical remedies.
(7) Deficiency Liability. Residential debtors who act in good faith are exempt from deficiency L.
Furthermore, debtor may present proof of FMV and have deficiency determined based on
90% of that value.
(8) Residential Debtor Concept. Includes homeowners and anyone personally liable on
obligation secured by a home. Entitled to certain protections.
x) Disbursement of Proceeds. Surplus stands in place of foreclosed real estate, and liens & interests
that previously attached to the real estate now attach to surplus. Liens are entitled to be paid out
of surplus in order of priority they enjoyed pre-foreclosure. Statutes often regulate surplus.
(1) Order. Costs of foreclosure sale are paid first. Then liens are paid in order of seniority. Must
be liens on actual property – e.g., credit card debt is not secured and thus irrelevant. If
there’s surplus left over, then it goes to MR who was foreclosed.
(2) Process. Some statutes codify these principles. Others, on their face, give the surplus to MR
– he must then answer junior lienor rights. Some make no mention of priority, but authorize
ME or trustee to pay the surplus to clerk of court.
xi) Reacquisition of Title by MR. Foreclosure sale extinguishes rights of junior lien. If MR reacquires
prop at foreclosure, however, junior lien is revived. MR only gets free & clear if he purchs from
g) Statutory Redemption.
i) Overview. About ½ the states have statutory right of redemption providing additional time period
for MRs, their successors in interest, and in some instances, junior lienors, to pay foreclosure sale
price to redeem title to property.
ii) Price. Under statutory redemption, price is tied to foreclosure price. Contrast: in equitable
redemption, pay mortgage debt – however, junior lienor doesn’t get title, but rather just gets to
reinstate the mortgage and move up.
iii) Length. EOR ends at foreclosure; that’s when statutory redemption begins.
iv) Order. Some use strict order, whereby there’s a priority order in which redemptions may be
redeemed. Some use scramble method, any interest – junior or MR – can pay off. Next redeeming
party must pay previously redeeming lienor foreclosure price and sometimes amount of the lien.
v) No Stat Redemption when Fed Gov is ME. State statutory redemption is inapplicable to when fed
gov is ME. Indicates fed gov views statutory redemption as contrary to its interest as ME. While
statutory redemption is meant to protect jr. lienors by getting FMV, if price is too low they can bid!
vi) Lien Revival After Statutory Redemption. Many courts endorse revival of all jr. liens existing prior
to sale. In some states, even lien of foreclosed mortgage is revived to the extent of any unpaid
deficiency. But states like CA say liens are extinguished by sale and don’t reattach.
vii) GE of MR as Redeeming Party. In most JXs, MR’s statutory redemption right is assignable. Courts
split when GE redeems – some say previous junior liens against MR revive against redeeming
GE. Others say redeeming GE takes clear of liens, even if they’d revive if MR redeemed.
viii) Redemption by Junior Lienor. Under most statutes, redemption by junior lienor gives him same
title that the foreclosure sale purchaser would’ve obtained had there been no redemption – thus,
junior liens do not revive.
h) Anti-Deficiency Legislation.
i) General Rule. Upon default, ME can foreclose on property, and if proceeds are insufficient to
satisfy mortgage obligation ME can obtain deficiency. This is automatic in judicial sale; for power
of sale, deficiency judgment must be sought. ME’s right to deficiency is regulated – many states
have notice and timeliness reqiuirements. There are a few outlier approaches:
ii) One Action Rule. Many JXs have “one action” rule limiting ME’s remedy to foreclosure. ME must
obtain deficiency judgment incident to this proceeding. Protects MR from multiple actions.
Sometimes apply to power of sale foreclosures, where exercise of the power is condition
precedent to subsequent action at law for deficiency.
iii) FMV for Deficiency. Some stats require use of FMV, rather than sale price, to determine
deficiency. Determining FMV may be left to statute, court, or jury. Arose in Depression. Such
legislation assumes that price in forced sale will be less than in a private sale. Other stats use
iv) Ban on Deficiency. Some JXs simply ban deficiency judgments.
v) Restrict Deficiency. Some JXs restrict deficiency judgment by fair value legislation or appraisal
statutes. If mortgage debt and costs are below upset price, then no deficiency.
8) PRIORITY PROBLEMS
a) Purchase Money Mortgs.
i) Definition. Purchase money mortgage is mortgage loan given in lieu of cash for purchase of prop.
The loan is used to secure a portion of the purchase price. They make it possible to sell property
when mortgage $ is unavailable or when buyers are unqualified. Seller gets priority based on
notion that she extended security based on the security of the actual land.
ii) Priority. Key to PMM rule is to allow PM-ME to gain priority over liens only where lien is riding on
shoulder of PM-purchaser until he gets title. But PM-ME cannot take priority over lien that already
attached to property itself. Thus, PMMs take priority over judgment liens, after-acquired prop liens,
mechanics liens, etc. Hospital liens (Stevenson), for example, don’t attach to prop – like judgment
liens in that they’re carried around on MR’s shoulders until he acquires property.
(1) Public Policy/Legislation. Liens that don’t attach to land don’t have priority, even if ME is on
notice of them. Only way to change this is by statute. Other way is to make a public policy
argument on the facts of your case.
iii) Construction Loans as PMM. Oftentimes, proceeds of mortg loan are used not only to acquire title
to prop, but also to construct building thereon. Portion used for land clearly qualifies as PMM.
Courts disagree on the other part – Rest.and some courts treat it all as purchase money (if part of
trsxn to buy land), while some courts say the portion used for construction is not purchase money.
iv) Recording Acts. PMM need not be recorded to protect ME against judgment liens or other claims
on the real estate arising against purchaser-MR prior to MR’s acquisition of title. However, PMM
may still be junior to subsequent ME if PMM is not recorded.
v) Vendor PMM v. 3d Party PMM. Generally, vendor PMM gets priority over 3d party PMM, even if
vendor’s PMM was for smaller amount (down-payment). If the 2 are aware of each other, then 3d
party is on notice. If neither party has notice, vendor again prevails. If only one party has notice,
however, recording statute guides.
(1) Subordination of Vendor. Most 3d party lenders are required to hold first mortg. They achieve
this by having the PM-ME subordinate her lien. PM ME will usually agree bc they want to get
the prop sold and they prob assumed they’d be second anyway. Vendor’s mortgage should
specifically refer to the 3d party mortg and declare its subordination to it.
b) After-Acquired Property Clause.
i) Overview. This clause tries to attach mortgage to prop acquired by MR after execution.
ii) Must be Clear. Mortg must either contain express terms that it’s intended to cover subsequently
acquired prop or it must clearly appear from deed language that it was manifest intention of
parties. Such clause is valid bc equity leads court to give effect to the K – equitable lien.
iii) Priority. Problems arise when valid PMM is executed on after-acquired land w/ an equitable lien.
Notice is hard for ME2 to get, bc to get it he’d have to check not the parcel he’s acquiring, but
instead look at other lots owned by MR – most theories on chain of title say you only have to
check the given piece of property. In most JXs, subsequent PMM w/o notice would take priority,
but as we saw in Hickson this is not always the case.
iv) Validity of AAPCs. In some states, AAPC is valid to create equitable lien provided the new prop
bears a functional relation to the prop originally mortgaged. In other states, the AAPC is effective
to create an equitable lien only for public utlities or railroads.
v) Relationship to Accession & Law of Fixtures. If a person owns property burdened by mortgage
and MR makes improvements to that property (fixtures) this becomes actual part of the prop and
is covered by the existing mortgage – no AAPC needed.
vi) Recording Act & Chain of Title Problems. Have to determine when AAPCs are effective against
those who take subsequent interests in after-acquired parcels must look at state recording acts
to determine what constitutes constructive notice. Restatement treats recorded mortgage
containing an AAPC as unrecorded as against those who later take interests in after-acquired real
vii) AAPC v. PMM. If subsequent purchase is w/ a PMM, then PMM-ME is probably senior to
equitable lien of ME1 from AAPC due to PMM rule – the AAPC attaches to the MR and jumps on
to the prop!
c) Replacement & Modification of Sr. Mortgs: Impact on Jr. Lienors.
i) Rule. When the holder of senior mortgage discharges it and contemporaneously takes new
mortgage, she will not be held to have subordinated her security to an intervening lien unless
there are “paramount equities” (junior lienor detrimentally relied on release of the mortgage).
ii) Construction Loan Mortgs. Most common area of replacement mortgs. Often, construction lender
becomes permanent lender. Lender releases construction mortg & then records permanent mortg.
Original mortg remains unsatisfied. For short period, prop is free of senior encumbrances – gives
way for jr. interests’ to act opportunistically. Normally fruitless, unless paramount equities.
(1) Paramount Equities. Junior lien recorded during interim that lacks notice to senior lien. Also
perhaps if replacement lien prejudiced junior lienholders in some way, then junior may be
able to get bumped in priority (i.e., replacement ups principal or interest rate).
iii) Modification of Sr. Mortg: Impact on Jr. Interest. Common for sr. ME and MR to amend existing
mortg. If modification is such that it prejudices rights of jr. lienors or impairs their security, their
knowledge & consent is required. Modification must be materially prejudicial! Looking for more
than an extension of repayment time; need to have an increase in principal or in rate. If lienor
agrees to subordinate based on certain terms of sr. mortg and then that mortgage’s terms are
modified, court may reorder priority. Very rare for court to elevate jr. interest above a sr.
iv) Sr. Mortg Language Reserving Right to Modify. Allowable, but it may deter later potential junior
interests – e.g., if amount of principal is uncertain. Rest. deals w/ this by allowing “cut-off notice” –
notice to ME that terminates the right to modify.
v) Sr. Mortg Replaced by New Lender. If equitable subrogation applies, new mortg held by MR, who
used proceeds of new mortg to extinguish earlier mortg, may receive same priority as earlier
mortg. Problem is unjust windfalls for junior lienors. Applies to debts of original debtor.
(1) Majority. No equitable subrogation if ME had actual notice of junior liens. Reasons if ME
didn’t have actual notice of junior lien, ME expected to step into shoes of previous creditor it
paid off. However, this has potential to promote ignorance.
(2) Minority. No equitable subrogation if ME had actual or constructive notice of existing lien.
(3) Restatement. Disregards notice if junior lien holders are not prejudiced. ME subrogated when
it pays entire loan of another if it was promised repayment and expected to receive security
interest w/ priority of mortg being discharged, and if subrogation won’t materially prejudice
holders of intervening interests.
9) GOVERNMENT INTERVENTION & PRIVATE RISK-SPREADING IN THE MORTG MARKET
a) Mortgage Lending in America.
i) Prevalence. Just under ½ of the debt in America is mortgage debt.
ii) Origination. Origination of mortgages is performed by commercial banks, mortg banks, & “thrifts”
(S&Ls and savings banks). Origination starts w/ receiving loan application. Originator then makes
necessary appraisal & credit checks, sees that the necessary docs are executed, and disburses
loan payment (in PMM, they pay seller). Once this occurs, loan has been originated.
iii) Options for Originator.
(1) Hold Loan. Originator may hold loan and collect monthly payments. Or originator may assign
it for consideration. All mortg bankers do is originate loans with expectation of selling them
off to investors. Mortg bankers can operate w/ little capital since funds they disburse at
origination will be recouped shortly when the loan is sold to an investor.
(2) Sell. Originator may also sell loan to another institution on secondary mortgage market. Life
insurance companies, depository institutions, and 3 federally chartered institutions (Fannie
Mae, Freddie Mac, and GNMA) are primary secondary market purchasers. Most secondary
market purchasers K with originator to handle servicing of the loan for a fee.
(3) Securitize. Originator may place loan in pool w/ others of similar characteristics & “securitize”
them (sell off interests in loan pool to the public). Could sell participation certificates (PCs) to
investors. May also sell securities backed by mortgages (MBS).
iv) Construction Loans. Short-term – end w/ construction. Lender is typically local, and it’s rare for
these loans to be securitized or sold on secondary market. When construction is done, lender
makes disbursement of long-term loan funds. Alternative involves use of single set of docs for
construction & permanent loans – provide for accrual of interest & no principal payments during
construction. When construction is done, docs require start of regular principal & interest
payments; at this point construction lender sells loan on secondary market under “buy-sell
b) Financial Institutions & Their Regulators.
i) The Lenders. Commercial banks and S&Ls (also called “thrifts”) traditionally have been originators
and provided funding for mortgage loans. Their identities have tended to MERGE together.
(1) Life Insurance Companies. Have over time been involved in making permanent loans in
commercial real estate area. Not as heavily involved these days as they have been in past.
(2) Mortgage Bankers. Originate a lot of home mortg loans then ship them off. Get their money
to do this by pledging them to a bank which provides them funding. Also do a lot of servicing
(3) REITs (Real Estate Investment Trusts). More emphasis these days on them having
ownership interests than being lenders.
ii) Regulators. Regulatory bodies each have area of primary JX; sometimes lenders have to comply
with two regulators (frustrating).
(1) Office of the Comptroller of Currency (OCC). National banks, federal braches, and agencies
of foreign banks.
(2) Federal Reserve System (FRS). State-chartered, FRS member banks; bank holding
companies and their subsidiaries; and foreign banking organizations operating in the U.S.
(3) Federal Deposit Insurance Corp (FDIC). State-chartered, non-FRS member banks & state
(4) Office of Thrift Supervision (OTS). Federally & state-chartered thrifts and thrift holding cos.
c) Gov’t-Sponsored Mortg Market Support Institutions.
i) Overview. Many mortgs originated then sold. Many of these mortgs are put into “pots”; people can
buy “ladle full” of mortgages as securities. During Depression, FNMA was created to buy up
mortgs and hold them. Idea was that they need to free up money to be loaned out to others.
FNMA has evolved into other government-connected entities: Freddie Mac (focused on S&Ls),
ii) Mortgage Backed Securities (MBS). These have gotten more and more sophisticated in how they
divide the pool to appeal to different kinds of investors.
d) Predatory Lending.
i) Overview. Predatory lending involves range of practices (faud, deception, manipulation, etc) that a
mortgage lender may use to make a loan with terms that are disadvantageous to borrowers.
Occurs most often w/ sub-prime loans.
ii) Federal Response. HOEPA is the only federal law designed to deal w/ predatory lending, but
federal agencies have also taken action. FTC has filed suits and won; DOJ and HUD have also
entered into settlements, using laws like RESPA and the Fair Housing Act.
iii) State Response. 11 states have passed their own legislation on predatory lending. Generally
cover a variety of practices, such as balloon payments and prepayment penalties.
iv) Subprime Loans. Sub-prime lending is lending to marginally-qualified individuals. In 2002, 63% of
subprime loans ($134B) were securitized and sold on secondary market. This increases funds for
subprime lenders, potentially lowering rates and origination costs. However, subprime lenders
often sell off the mortgs quick – they make money from origination fees, and they don’t lose
incentive to lower those at all.
(1) Open Question. When does sub-prime lending become predatory?
(2) Solutions. Some institutions (FDIC) have tried to start educational programs for lenders. To
little avail – very complex; predatory lenders are very aggressive; and finally, target
consumers are some of the hardest to reach w/ educational efforts. Things like HUD
disclosures also help little due to the complexity of info. Pre-purchase mortg counseling may
help – lets 3d party check out the loan. However, hard to get some borrowers to go.
e) Spreading Mortgage Risk – Insurers & Guarantors.
i) Risks. Equity is a very important feature of risk. So too is credit score and L-V. Most insurers are
private, and they provide first claim insurance – that is, they pay a % (usually 25) of claim amount.
ii) Mortg Insurance. Mortgage insurance protects lenders against losses against in event of default;
borrower ends up paying a premium. Lenders often require insurance when down payment is less
iii) Options for Lenders to Spread Risk.
(1) Lenders can make careful selections on potential borrowers, considering income, credit, &
equity investments. Lender expects to make sufficient profit margin on overall loan portfolio
to enable them to absorb occasional loss on defaulting loan.
(2) Lender can offer loan at lower L-V ratio. If mortgage has low L-V, borrower will have more
equity in property and can simply sell the property in order to avoid a default.
(3) Lender can K with a mortgage insurer to absorb risk.
(4) Lender has a variety of other options, including temporarily suspending interest payments,
extending maturity of loan, or adjusting the interest rate.
iv) Conventional Mortg Market. FNMA and Freddie Mac are government sponsored private corps with
missions to provide continuous flow of funds to mortgage lenders and borrowers. They purchase
mortgages from lenders across the country and finance their mortg purchases though borrowing
or issuing MBS that are sold to investors.
(1) Trend: High LTV Loans. There’s been push toward supporting low and no down payment
mortg products. Many private mortg insurers will now insure a mortg up to 100% of the value
of house being purchased. FNMA and Freddie Mac have been big in developing high LTV
products that target low-income or first-time homebuyers. They’ve been buying more.
(2) Research. However, some research shows that high-LTV loans are more likely to fail and,
when they do, defaults are larger. Credit scores are a great predictor, too.
v) Insurance Limits. Most mortg institutions limit mortgs it may insure. Varies by location & prop type.
vi) Mortg Scoring & Automated Underwriting. Increasingly used. Scoring is based on technology that
uses statistical samples to determine how key factors affect loan performance. Used to make
FICO scores as well. Automated underwriting is done w/ the info gathered in the underwriting
f) Alternative Mortgage Instruments.
i) Why Have Alternative Mortgs. Portfolio lenders need it to protect against risk of lending on long-
term fixed-rate mortgages – if short-term rates spike, lender is screwed. Also, if rates change then
the instruments will be far more attractive to lenders.
ii) AMPTA of 1982. State chartered institutions permitted to offer same mortgs to borrowers as
allowed under federal law. But states can decide otherwise. Allows state institutions to compete
with federally chartered institutions
iii) Making the Loan. Lenders look at mortgage payment to income ratio. Most companies use about
30% -- if you make $4,000/month, you can pay up to $1,200/month. Interest rates reflect this.
iv) Adjustable-Rate Mortg (ARM). Permits lender to modify interest rate periodically in accordance
with some index of relevant rates. Benefits lender bc risk of fluctuations over time is shifted from
lender to borrower, and will approximate that which would be earned on series of short-term loans.
v) Price-Level Adjusted Mortg (PLAM). Lender charges only interest, but principal balance on loan is
adjusted periodically to reflect actual inflation (as measured by Consumer Price Index)
vi) Reverse Annuity Mortg (RAM). Designed to allow elderly/retired persons who have large equities
in their homes to “borrow out” these funds on a regular basis to help pay their living expenses.
Lender makes monthly disbursements to homeowner, & outstanding balance on loan rises to
reflect these disbursements and interest. Eventually, loan is repaid by sale of prop.
vii) Graduated Payment Mortg (GPM). Interest rate fixed, but payments vary in accordance with pre-
arranged schedule, typically climbing X percent each year for first Y years of loan and then
remaining constant for the remainder of the term
viii) Shared Appreciation Mortg (SAM). Borrower pays fixed interest rate over designated period of
time. At the end of designated period, lender will be entitled to portion of appreciation of the
property, which will presumably reflect inflation.
i) Types of Subdividers. Three types of subdividers: (1) remote (purchase raw land and try to sell it
to people who dream of owning own land – Cong has acted against this); (2) suburban lot seller
(also doesn’t build houses, but it’s fringe suburban area and builder puts I necessities); (3)
merchant builder (operate in suburban areas, build houses on each lot).
(1) Market. Developer starts out trying to find out if there’s a market. Do sophisticated studies to
make sure there’s a need. But sometimes they just go off of instinct.
(2) Location. Three most important things “location” “location” “location.” May be able to rely on
land speculators who have gone out to find desirable sites.
(3) Obtain Land. Sometimes they own the land, but other times they have to buy. They may
want to enter into an option instead of a firm K. This allows them the option to buy, and if
they choose not to it’s only a small cost. During this time, they make sure land is worth
developing (look into planning & engineering, environmental impact report, get rezoning
(4) Financing. Construction financing and permanent financing.
(5) Closing. K will be closed; option will be exercised. Need to file a plat of the subdivision.
iii) Construction Loan. Usual source of financing for builder to finance improvements. Short-term loan,
paid off when each lot is sold. Usually by local investors, mainly commercial banks.
(1) Risk. Construction loans riskier than permanent. One problem is money that’s supposed to
go to construction gets used elsewhere. Second, could have bad weather or economy that
could affect ability of borrower to pay back. Third, issue of mechanics liens. Foreclosure is
possible, but the prospect of taking half-complete project is not great – and the same
problems are there
(2) Top Lien. Construction lenders usually insist on first lien position, which means if developer
bought on credit (PMM) that seller must agree in security docs or in separate agreement.
(3) Permanent Financing. Important to construction lender that permanent financing is available
on each house at end of construction – if not, they might not sell & developer is unable to
pay. Some lenders require this “take-out” commitment be in place before lending.
(4) Construction Loan Agreement. Good way to ensure funds disbursed go to construction.
Often provide that funds are distributed based on progress. Also may endorse voucher
system (developer pays workers and presents receipts to lender) or direct disbursement
(5) Payoff. When house is finally sold, homeowner will obtain permanent financing and pay
developer; developer turns around and pays pro-rata share to construction lender.
iv) Mechanics’ Liens. Problem for all involved. Such liens can be filed on prop by laborers,
subcontractors, and materials suppliers if developer fails to pay. In many JXs, effective date of
priority relates back to first day of work. Also, lienor often has until months after work is complete
to file lien. Bc of this, construction lenders go to great pains to ensure their CLM is recorded before
any work on prop. Some insurers excluded mechanics’ liens from their policies.
v) Loan Commitments. Construction & permanent loans are preceded by loan commitments – written
promises by lenders to make loans when certain conditions are met. For permanent loans, lender
will reserve right to review credit and income of individuals. Also, construction lender will often
require developer to find permanent lender, too.
(1) Breach. If the commitment is breached by developer, damages may be the commitment fee
– the damages are the lost opportunity. If breached by lender, they can probably go for
damages – however, SP to lend the money would be hard to get.
b) Purchase Money Land Financing.
i) PMM. Developer persuades land seller to extend credit for large part of purchase price. Seller will
then convey fee by deed to developer and receive mortg to secure unpaid balance of purch price.
ii) Institutional lenders will almost always require that the construction loan be given priority over the
PMM, and parties will employ various devices to subordinate the PMM to the construction loan.
iii) “Automatic subordination”. Language in PMM by which land seller aggress to be subordinate to a
construction loan made in the future.
iv) Some courts provide that the enforceability of a subordination agreement is based in the fairness
and reasonableness to seller. The definiteness of the subordination agreement is only one factor
in determining if it is fair and reasonable. In order to be fair and reasonable, subordination
agreement must at least include maximum principal and maximum interest rate of construction
loan. Beyond these terms, courts disagree about which terms need be included in order for
subordination agreement to be fair and reasonable.
v) If the terms are not included in subordination agreement, construction loan lender will usually be
permitted to determine those terms based upon current market rate and current customs of
vi) Seller may provide in subordination agreement that PMM will only be subordinated if construction
loan funds are used “for improvements.” If developer violates this condition of the subordination
agreement and diverts fund, construction lender will have a loss of priority to reflect only the loss
suffered by PM seller (not a complete loss of priority).
c) Mechanics’ Liens.
a. Overview. Persons who furnish labor or materials for improvements of real property of another
have a right to a statutory lien on that property to secure payment for their services and materials.
b. Statutes. Under the statutes, the lien attaches to the property interest of the owner.
a. Under NY system, the amount of mechanic’s lien is limited to amount due to original
contractor from the owner
b. Under PA system, each mechanic’s lien attaches to full extent of fair value of his
contribution, regardless of the state of the account between owner and the contractor.
c. Filing the Lien. Lienor must notify owner of claim and intention to file mechanic’s lien w/i specified
period following last day upon which he contributed to improvement. Lien itself need not be filed
for 6 months.
d. Priority. Mechanic’s lien relates back to start of construction on project, even though mechanic’s
lien is not filed until 6 months after lienor ceased to furnish labor or material for the improvement.
d) Construction Loans & Other Mortgs to Secure Future Advances.
i) Overview. Mortg that secures “future advances” is one in which not all of the funds whose
repayment is secured by mortg are disbursed immediately to borrower. Some of the funds will be
advanced later, but with expectation that original mortg will secure additional balance as well.
ii) Requirements. Mortg will secure future advance only if partners to the mortgage so agree and if:
(1) Mortg states that repayment of future advances is secured; or
(2) Person acquiring an interest in the real estate has other notice of parties’ agreement
concerning future advances at the time the interest is acquired; or
(3) Mortg states a monetary amount to be secured and advances do not cause the indebtedness
to exceed that amount.
iii) Dragnet Clause. States that the property which is covered by mortgage will stand as security not
only for the loan now being made, but also for any other indebtedness on which borrower may
now be liable or may become liable to lender in the future until mortgage is satisfied.