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