Nearly all all homes are financed when they are purchased. But what is the process for obtaining and financing real property? The remainder of this article goes to show how this process works. Below is a brief summary of what will be covered.
First, the borrow creates an obligation by drafting a promissory note to repay the loan.
Second, the borrow provides security, such as a mortgage or deed of trust, which places an encumbrance on the property as collateral if the borrower fails to repay.
Third, the lender has the right to foreclose on the property, through the security, to collect proceeds from a default.
Finally, both the lender and the seller have certain rights after the foreclosure which will be discussed.
Creating the Obligation
A borrower promises to pay back a loan and as a result has obligated themselves to payback the loan. The formal writing of an obligation is done through a promissory note. This note often contains a clause that demands repayment of the loan in full if the borrower defaults even once (acceleration clause). Additionally, the loan is to be repaid when the property is sold through a “due-on-sale” clause.
Assuming v. Taking Subject
When a subsequent buyer assumes the loan, then they adopt the remainder of the loan and are subject to enforcement. If they fail to make payments, the previous borrower can sue for damages.
However, if the new buyer takes the property subject to the loan, then they will not be personally liable for any defaults but the original purchaser would be liable.
Providing the Security
Although the mortgage is the most common security, there are several other types of securities used to secure a financing. A security is used to secure the obligation. Simply, it is the lender’s collateral damage for a default.
Mortgage
A mortgage is the traditional way to provide security on a loan. In essence, the borrower promises to pay back the loan. If the borrower fails to make payments, the lender has the right to take possession of the property, foreclose, and use the proceeds to cover the losses sustained.
There are three main loan theories:
- Title – The lender has title and the right to possession at the time of the loan.
- Intermediate – The lender maintains title but does not have the right of possession until default.
- Lien – The borrower maintains title and possession until default. Iowa is a lien theory jurisdiction.
A couple other notes to make about a mortgage is that foreclosure is the usual method of recovery. Additionally, mortgages are recorded and treated as encumbrances on the property. However, a mortgage does not need to be recorded to be recovered. Simply, the first mortgage recorded receives priority if a home is foreclosed.
Deed of Trust
A deed of trust is the most common substitute for a mortgage. What it provides is for a trustor (the borrowers), through the trust of a third party (the trustee), to protect the home for the beneficiary (the lender). In essence, the deed of trust is simply a mortgage with a third party attached. When a default occurs, the lender can require the third party to sell the defaulted property and give the proceeds to the lender. Why the different document? Lenders attempted to create the document as a work around to avoid certain rights afforded to borrowers through mortgage laws. However, the work around was denied by the courts, effectively making a deed of trust a mortgage with the power of sale (the right to foreclose without judicial guidance).
Installment Land Contract
An installment land contract is a contract where the lender retains title of the property and the borrower retains possession while making installment payments. If the borrower misses a payment, then the lender has the right to reclaim the property. The issue with this contract is that the borrower may borrow for less than the worth of the land, make several payments, default, then lose both the property and the payments made. The following case discusses whether there is a remedy available for this problem.
Slone v. Calhoun
386 S.W.3d 745 (Ky. Ct. App. 2012).
Slone is the plaintiff who lost in trial court and appealed.
Question
What remedies are available to Slone, if any?
Rule
Under an installment land contract, forfeiture clauses cannot be enforced. The proper remedy is to judicially sell the land and divide the proceeds.
Holding
Reversed and Remanded.
Facts
Slone had purchased property and a mobile home on that property from Calhoun for 313/per month in 2006. Once the payments were made in full, Calhoun would transfer the deed to Slone. In January 2009, Calhoun created a similar deal with another party fro the same property that Slone was in. In May 2009, Slone was unable to continue making payments and moved from the property. She now sues for damages saying that Calhoun effectively kicked her out by selling her property to another party.
It turns out that the Calhoun intended to sell the adjacent property to the third party and the contract misidentified the correct property.
Thus, the trial court said that this was an installment land contract and Slone had forfeited her rights to the property or payments through her abandonment.
Analysis
Here, the only remedy available to the parties for the breach of contract is a judicial sale of the property. At that point, proceeds would be divided to each party respectfully. First, proceeds would be provided to Calhoun to fully pay for the property and any remainder would be delivered to Slone.
One thing to note is that Kentucky here completely refused to enforce forfeiture clauses. Traditionally, and many states still follow the traditional approach, forfeiture clauses can be enforceable. A forfeiture clause is when a party defaults and consequently forfeits their right to the property and the payments they made on the property. However, many jurisdictions have recently become averse to forfeiture clauses, especially when full payment has nearly been made. Instead, they treat an installment land contract as a mortgage with a judicial foreclosure as a remedy.
Additional Notes
The takeaway: There is no difference between an installment land contract and a money purchase mortgage.
Equitable Mortgage
Zaman v. Felton
98 A.3d 503 (N.J. 2014).
Zaman is the plaintiff and Felton filed counterclaims. Felton’s claims were dismissed at trial, and affirmed on appeal. This appeal followed.
Question
Is the sale in effect an equitable mortgage?
Rule
The court needs to examine 8 factors to determine if the sale is in reality an equitable mortgage:
- Statements of retaining ownership
- The price received is much less than the value of the home
- The existence of an option to repurchase
- Continued possession by the homeowner
- Homeowner continues to keep ownership duties
- Disparity in bargaining power and sophistication
- Irregular purchase process
- Financial distress of the homeowner, including the imminence of foreclosure
Holding
This could be an equitable mortgage. Reversed, and remanded.
Facts
Felton had conducted several home sales prior to this occasion. Here, she had obtained a construction mortgage but had defaulted and was about to have a foreclosure on the home. Then Zaman entered. He was a real estate agent. Felton, wishing to avoid foreclosure, offered to sell for 250,000. Zaman countered by offering 200,000 and that Felton could buy back the home within three months for 237,000.
The deal was executed, but no mention of a mortgage was discussed. Instead, the sale was made then later a lease agreement was enacted.
However, Felton failed to exercise the option to buy back the home, and did not abide by the lease agreement standards (living in the home for an additional 17 months).
Instead, Felton argued that the sale of the home for 200,000, and the additional agreements, was a loan. Thus, the result would be an equitable mortgage. So, the question becomes, is this a true sale instead of an equitable mortgage?
Analysis
In this opinion, the court does not determine if the specific contract was an equitable mortgage or not. Instead, they provide the trial court with instructions on how to determine what kind of transaction existed, a sale or a loan (disguised as a sale).
Interestingly, on remand, the trial court again determined that the transaction was a sale and not an equitable mortgage. Later, the legislature adopted a statute preventing the sale of an owner-occupied residence if foreclosure proceedings are pending under certain conditions.
Additional Notes
Again, this is a situation where the court is trying to determine if this is a sale or a disguised mortgage.
Factual Steps:
- Felton was in financial distress.
- She sold to Zaman for 200,000 with the option to buy back for 237,000
- She retains possession of the property.
Felton sees this transaction as a loan. Zaman sees this transaction as a sale. So, which is it? To determine the answer, the court considers the following factors:
- Statements of retaining ownership
- The price received is much less than the value of the home
- The existence of an option to repurchase
- Continued possession by the homeowner
- Homeowner continues to keep ownership duties
- Disparity in bargaining power and sophistication
- Irregular purchase process
- Financial distress of the homeowner, including the imminence of foreclosure
Foreclosing on the Security
Borrower’s Rights Before Foreclosure
If the borrow defaults, they can avoid foreclosure in two ways. First, if they make up the missed payment before acceleration (e.g. the bank demanding the full amount of the mortgage) occurs. This process is called reinstatement. Some jurisdiction allow reinstatement to occur even after acceleration as long as it occurs within a specified time. Second, the borrower can may back the entire debt anytime before the foreclosure sale occurs (called equitable redemption).
Judicial Foreclosure
This is foreclosure through the judicial system. A complaint is filed by the lender, an answer is made (but not usually) by the borrower, and a judgment authorizing foreclosure is provided. Thus, the borrower is notified of the time and place when the property will be sold. An action is held for the sale of the property, which goes to the highest bidder. Finally, the judge confirms the sale.
Nonjudicial Foreclosure
Same as judicial foreclosure, except without judicial oversight. Judicial oversight can be introduced if the lender begins foreclosure proceedings when they are not entitled to foreclose.
In a mortgage, the document will say that the mortgage is done with the “power of sale.” This is the majority rule among states.
Results of Foreclosure
Note the importance of priority. There can be several interests on a home at once, including multiple mortgages. Thus, there are two principles that occur when a home is foreclosed.
First, foreclosure eliminates the mortgage that the lender provided and any lesser interests. For example, assume there are three mortgages; M1, M2, M3, each recorded in order of priority. If M1 forecloses, then all three mortgages are cleared (M2 and M3 being lesser in interest and M1’s mortgage cleared with the foreclosure). However, if M2 forecloses, it only wipes out M2’s and M3’s mortgage while M1 remains.
Second, foreclosure sale proceeds are distributed first to the foreclosing lender, then to any lesser interests, then to the borrower. So, if M1 forecloses then sells, All proceeds will be used to cover M1, then M2, then M3, then the borrower. If M2 forecloses, the proceeds cover M2, M3, then the borrower.
The purpose of these principles are designed to protect the lender’s ability to recover loans based on the risks they adopted.
Special Priority Rules
Purchase Money Mortgage – Whether recorded or not, a purchase money mortgage has priority over other mortgages, liens that arise prior to mortgagor’s acquisition of title, but priority is subject to being defeated by subsequent mortgages under recording acts. (A purchase money mortgage is when a borrower gets a loan from a bank, specifically for the purchase of a home).
Future Advance Mortgage – If the lender is obligated to make additional loans, the new loan takes priority from date of original mortgage. If making a loan is options, then there is no priority over subsequent interests.
Deed in Lieu of Foreclosure – Conveys title to lender instead of going through foreclosure. Junior interests are not terminated. The lender takes title subject to those junior interests.
Rights after Foreclosure
Protecting the Borrower
The borrower has only two main rights after foreclosure occurs:
- Statutory right of redemption. A borrower can regain title by purchasing it from the highest bidder within a specified time (usually a year). They will pay the sales price, plus interest and costs, to exercise this right. Usually this action decreases the sale price at foreclosure.
- Setting aside the sale. The sale may be set aside if the price is substantially below the market value (about 20% less) or if there was a procedural irregularity (lack of notice or trying to discourage bidding).
Protecting the Lender
Although lenders can receive a deficiency judgment (the sale of the home was less than the amount left on the mortgage) for foreclosure, the practice is fairly disfavored. For example:
- Fair value. Deficiency judgment may be allowed if the property value does not exceed the initial loan amount.
- Prohibition. Deficiency judgments are not allowed at all.
- Judicial Approach. Deficiency judgments may be invalidated by a judge because of the inadequate of the sales price or unfair process.
Disclaimer
The content contained in this article may contain inaccuracies and is not intended to reflect the opinions, views, beliefs, or practices of any academic professor or publication. Instead, this content is a reflection on the author’s understanding of the law and legal practices.
