Mortgages/security devices - By mortgagee

Learning Outcomes

This article explains the rights and remedies of a mortgagee in secured real estate transactions, including:

• How and when a mortgagee can transfer the note and mortgage, the legal effect of assignments, and how negotiability and holder‑in‑due‑course status change available defenses and payment rules
• How foreclosure, pre‑foreclosure possession, and receivership operate as enforcement tools, and how each remedy affects the mortgagor’s equity of redemption, waste obligations, and ongoing income from the property
• How priority rules determine the relative rights of multiple mortgages and liens, with emphasis on purchase money and future advance mortgages, the impact of recording acts, and the consequences of subordination or modification agreements
• How foreclosure sales are conducted, how proceeds are distributed among senior and junior interests, and when extinguished junior lienors may still pursue the mortgagor personally on the underlying note
• When a mortgagee may obtain a deficiency judgment, how anti‑deficiency and fair‑value statutes, nonrecourse clauses, and consumer‑protection defenses restrict that remedy, and how these limitations are likely to appear in MBE‑style questions

MBE Syllabus

For the MBE, you are required to understand mortgages and other real estate security devices from the lender’s side, with a focus on the following syllabus points:

• The relationship between the promissory note and the mortgage as separate but linked instruments
• Transfer of the mortgagee’s interest: assignment of the note and mortgage, holder in due course issues, and payment to the wrong party
• Mortgagee enforcement: foreclosure methods, pre‑foreclosure possession, receivership, and equity of redemption constraints
• The effect of foreclosure on mortgagor, junior lienors, and senior lienors
• Priority among multiple mortgages (including purchase money and future advance mortgages), and the impact of recording acts and subordination agreements
• Deficiency judgments, distribution of foreclosure proceeds, and statutory limits and consumer protection defenses

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following is required for a mortgagee to transfer its interest to another party?
   1. Only the mortgage must be assigned.
   2. Only the promissory note must be transferred.
   3. Both the mortgage and the note must be transferred together.
   4. Either the mortgage or the note may be transferred alone.
2. When a mortgagee forecloses on a property, which interests are eliminated by the foreclosure sale?
   1. All interests, including senior mortgages.
   2. Only junior interests to the foreclosed mortgage.
   3. Only the mortgagor’s interest.
   4. All liens, regardless of priority.
3. If a mortgagee sells its interest but fails to notify the mortgagor, which party is entitled to payment if the mortgagor pays the original mortgagee in good faith?
   1. The original mortgagee.
   2. The transferee mortgagee.
   3. Both parties equally.
   4. The mortgagor is discharged from liability.

Introduction

A mortgagee, also known as the lender or secured party, holds significant rights and remedies under a mortgage or other security device. The mortgage itself is a security interest in real property that secures repayment of a secured obligation, typically a promissory note.

Key Term: Mortgagee
The lender or other party who holds the mortgage (or deed of trust) as security for repayment of a debt.

On the MBE, questions will often test what the mortgagee can do when things change: transfer the note or mortgage, enforce the security through foreclosure or possession, determine priority among multiple liens, and seek a deficiency judgment if the sale proceeds are insufficient. The same basic rules generally apply whether the security device is called a mortgage, deed of trust, or installment land contract.

Transfer of the Mortgagee’s Interest

A mortgagee may transfer its interest in both the mortgage and the secured debt to another party. The economic value is in the note; the mortgage is only security.

Key Term: Promissory Note
The borrower’s written promise to repay the loan. The note evidences the debt; the mortgage secures it with real property.

Key Term: Assignment of Mortgage
The transfer by the mortgagee of its rights under the mortgage and the secured debt to another party, typically by endorsement and delivery of the note and execution of a written assignment of the mortgage.

The “note follows the mortgage” vs. “mortgage follows the note”

Modern law treats the note and mortgage as closely linked, but the note is primary:

• If the note is properly transferred but the mortgage is not mentioned, the mortgage automatically follows the note. The transferee of the note gets the benefit of the mortgage.
• If only the mortgage is “assigned” but the note is not transferred:
  • In many jurisdictions, the transfer of the mortgage alone is a nullity, because there is no right to enforce the debt.
  • In others, equity treats the mortgage and note as a single unit, allowing the transferee of the mortgage to compel transfer of the note.

For MBE purposes, focus on this: a transfer of the note is sufficient to transfer the mortgage, but a transfer of the mortgage without the note is usually ineffective.

Methods of transferring the note and holder in due course

The note can be:

• Indorsed and delivered (if negotiable), or
• Assigned by separate written assignment (even if nonnegotiable)

Key Term: Holder in Due Course
A party who acquires a negotiable promissory note for value, in good faith, and without notice of defenses, and who takes free of most “personal” defenses of the maker.

To be a holder in due course (HDC) of a note secured by a mortgage:

• The note must be negotiable in form (payable “to bearer” or “to order,” for a fixed amount of money, with no additional obligations beyond standard clauses like acceleration and attorneys’ fees).
• The original payee must indorse (sign) the note.
• The original note must be delivered to the transferee.
• The transferee must give value, act in good faith, and have no notice that the note is overdue, dishonored, or subject to defenses.

An HDC takes the note free of most personal defenses (e.g., failure of consideration, fraud in the inducement, waiver, payment), but is subject to real defenses (e.g., infancy, duress, illegality, fraud in the execution, discharge in bankruptcy).

Because the mortgage “follows” the note, an HDC can enforce the note and foreclose the mortgage even when the mortgagor has personal defenses against the original lender.

Payment to the wrong party after transfer

When the original mortgagee has transferred the note, the mortgagor is still obligated to pay the current holder. But what if the mortgagor doesn’t know about the transfer?

• Negotiable note (majority UCC rule): Payment to the original payee does not discharge the mortgagor’s obligation once the note has been negotiated; the new holder can still demand payment.
• Nonnegotiable note: Payment to the original mortgagee does discharge the mortgagor’s obligation until the mortgagor receives notice of the transfer. The transferee’s remedy is against the transferor, not the mortgagor.

This distinction is a frequent MBE trap: look for facts indicating whether the note is negotiable and whether the mortgagor had notice of the assignment.

Worked Example 1.1

A bank lends $200,000 to a homeowner and takes a mortgage on the property. The bank later assigns the note and mortgage to another lender but fails to notify the homeowner. The note is nonnegotiable. The homeowner continues to pay the original bank. Who is entitled to the payments?

Answer:
Because the note is nonnegotiable, the homeowner is discharged from liability by paying the original bank until notified of the assignment. The transferee lender’s remedy is against the original bank, not the homeowner.

Enforcement Rights: Foreclosure, Possession, and Receivership

When the mortgagor defaults, the mortgagee has several remedies. The most important is foreclosure, but the mortgagee also has pre‑foreclosure rights.

Pre‑foreclosure rights: possession, waste, and redemption

States follow different theories of what a mortgage conveys:

Key Term: Lien Theory
The mortgage is treated as a lien only; title remains with the mortgagor. The mortgagee has no right to possess before foreclosure.

Key Term: Title Theory
The mortgage gives the mortgagee legal title, subject to a right in the mortgagor to get title back upon payment. The mortgagee may have a right to possession before foreclosure.

Key Term: Intermediate Title Theory
A hybrid approach where the mortgagor retains title until default, at which point the mortgagee may take possession before foreclosure.

• In lien theory states (the majority), the mortgagee generally cannot take possession before foreclosure.
• In title or intermediate title theory states, the mortgagee may have the right to possession after default, especially if the property is abandoned.

Regardless of theory, the mortgagor has a duty not to impair the mortgagee’s security:

Key Term: Waste
Conduct (affirmative, permissive, or sometimes ameliorative) that substantially impairs the value of the property as security for the mortgage.

The mortgagee can seek an injunction or damages for waste if the mortgagor’s acts threaten the adequacy of the security.

Key Term: Equity of Redemption
The mortgagor’s common law right to prevent foreclosure by paying the full amount due (plus interest and costs) before the foreclosure sale.

The equity of redemption:

• Exists in every mortgage, unless validly cut off by foreclosure.
• Must be exercised before the foreclosure sale; after the sale it is lost (though some states offer a separate statutory right of redemption).
• Cannot be “clogged” at the time the mortgage is created. Courts are suspicious of terms that effectively prevent the mortgagor from redeeming, such as an advance waiver of the right to redeem.

Key Term: Deed in Lieu of Foreclosure
A voluntary conveyance by the mortgagor to the mortgagee, in exchange for release from the debt, used as an alternative to foreclosure.

A deed in lieu of foreclosure is permissible if voluntarily agreed to after default; it does not “clog” the equity of redemption.

Foreclosure

Key Term: Foreclosure
The process by which a mortgagee forces the sale of the mortgaged property to recover the unpaid debt after default.

A foreclosure is a forced sale of the collateral to satisfy the debt. There are two main methods:

Key Term: Power of Sale
A clause in a mortgage or deed of trust authorizing the mortgagee (or trustee) to sell the property without judicial action in the event of default, if permitted by state law.

• Judicial foreclosure: A court‑supervised sale, typically conducted by the sheriff.
• Nonjudicial (power‑of‑sale) foreclosure: Conducted by the mortgagee or a trustee under a power-of-sale clause, allowed in many deed‑of‑trust states.

Before foreclosing, the mortgagee must give notice to the mortgagor and to all parties whose interests the mortgagee seeks to cut off (usually all junior lienholders). Failure to give reasonably required notice to a junior interest holder means that junior interest is not eliminated by the sale.

Foreclosure proceeds are distributed in a strict order (discussed further below). If the sale price is insufficient to pay the debt, a deficiency may remain.

Possession and Receivership

Instead of, or in addition to, possession, a mortgagee can ask the court to appoint a receiver.

Key Term: Receiver
A court‑appointed third party who takes possession of the property and collects rents and profits during foreclosure or litigation to protect the mortgagee’s security.

Appointment of a receiver is an equitable remedy, more likely when:

• The property is income‑producing (e.g., apartments, office building).
• The mortgagor is insolvent.
• The property is inadequate security for the debt, or waste is occurring.

The receiver’s collections are applied to taxes, insurance, operating expenses, and then to the mortgage debt.

Effect of Foreclosure on Other Interests

Foreclosure affects the interests of other parties with claims against the property. The key is priority.

Key Term: Junior Interest
A lien or other interest that is subordinate in priority to the foreclosing mortgage, usually because it arose or was recorded later.

Key Term: Senior Interest
A lien or other interest that has priority over the foreclosing mortgage, usually because it arose or was recorded earlier.

General rules:

• Foreclosure eliminates all properly joined junior interests (mortgages, judgment liens, etc.). These parties must be named in the foreclosure action to bind them.
• Senior interests are not affected. The buyer at foreclosure takes subject to senior mortgages and other senior liens, which remain on the property.

If a junior lienholder is not joined in the foreclosure:

• Their lien is not wiped out.
• The foreclosure buyer takes subject to that lien.
• The junior lienholder can later foreclose its own lien.

Foreclosure also terminates the mortgagor’s legal and equitable interests in the property (subject to any statutory right of redemption).

Worked Example 1.2

A property is subject to three mortgages: Mortgage 1 (recorded first), Mortgage 2 (recorded second), and Mortgage 3 (recorded third). Mortgage 2 forecloses and sells the property. Which interests are wiped out by the foreclosure?

Answer:
The foreclosure sale eliminates Mortgage 3 (the junior interest) but does not affect Mortgage 1 (the senior interest). The buyer takes subject to Mortgage 1. Mortgage 2 is paid from the sale proceeds to the extent funds are available.

Priority Among Multiple Mortgages

The priority of mortgages determines who gets paid from foreclosure proceeds and which liens survive.

The general rule is “first in time, first in right”: earlier interests have priority over later ones. Recording acts refine this rule.

Recording statutes (race, notice, and race‑notice) apply to mortgages just as they do to deeds. A subsequent mortgagee who qualifies as a bona fide purchaser for value without notice of a prior unrecorded mortgage may take priority under the applicable statute.

Purchase money mortgages

Key Term: Purchase Money Mortgage
A mortgage given to secure a loan used to acquire title to the property, including one given to the seller or to a third‑party lender at the time of purchase.

A properly recorded purchase money mortgage (PMM) generally has priority over earlier non‑purchase money mortgages and liens, even if those earlier interests were recorded first. PMM priority usually applies:

• Whether the lender is the seller or a third‑party.
• Only as to the amount actually used to acquire the property.

Always check whether you are dealing with:

• A PMM vs. a non‑PMM; and
• A senior vs. junior foreclosure.

PMMs are often favored in priority disputes on the MBE.

Future advance mortgages

Key Term: Future Advances
Additional loan amounts that the mortgagee may or must lend in the future under the same mortgage, up to a stated maximum.

Many mortgages secure not only a present loan but also future advances (e.g., revolving construction loans). Priority of future advances usually depends on whether the lender is obligated to make the advance:

• Obligatory advances (the mortgagee is contractually bound to lend more up to a limit): usually share the same priority date as the original loan.
• Optional advances (lender may, but need not, advance more): if the lender makes an optional advance with notice of an intervening lien, that advance may be subordinated to the intervening lien.

Carefully read the facts to see whether the future advance was mandatory or discretionary and whether the lender had notice of intervening interests.

Subordination and modification

Mortgagees can contractually rearrange priorities:

• Subordination agreements: A senior mortgagee may agree to subordinate to a junior mortgage. These agreements are enforceable and bind successors with notice.
• Modification of senior mortgages: If a senior mortgage is later modified to increase the interest rate or principal, the modification may be subordinated to intervening junior liens to the extent it materially prejudices them. The original senior amount retains its priority.

Deficiency Judgments and Limits on Remedies

If the foreclosure sale proceeds are insufficient to pay the mortgage debt in full, the mortgagee may pursue a personal judgment against the obligor(s) on the note.

Key Term: Deficiency Judgment
A personal judgment for the difference between the mortgage debt and the proceeds realized at a foreclosure sale.

Who can be liable for a deficiency depends on contract arrangements (e.g., whether a subsequent buyer assumed the mortgage or took subject to it), but for the mortgagee, any person personally liable on the note can be pursued.

Distribution of foreclosure sale proceeds

The order of distribution is:

1. Costs of sale (attorney’s fees, court costs, trustee’s fees)
2. Foreclosing mortgagee (including accrued interest and allowed fees), up to the amount of the debt
3. Junior lienholders in order of priority
4. Any surplus goes to the mortgagor

If the sale does not generate enough to pay the foreclosing mortgagee in full, the unpaid balance is the deficiency.

Worked Example 1.3

Blackacre is worth $300,000. It is encumbered by:

• Mortgage 1: $200,000 (recorded first)
• Mortgage 2: $100,000 (recorded second)

Mortgage 1 forecloses. The sale brings $210,000 after costs. How are the proceeds distributed, and what are the mortgagee’s rights?

Answer:
Mortgage 1 receives $210,000 (up to its $200,000 debt plus interest and costs) and is fully paid; Mortgage 2 receives nothing. Mortgage 2 is wiped out as a lien on Blackacre but may sue the mortgagor personally on the note (if allowed by state law). Mortgage 1 has no deficiency.

Statutory limits on deficiency judgments

Many states limit or prohibit deficiency judgments in certain situations, especially for residential or purchase money mortgages, or when nonjudicial foreclosure is used. Common approaches:

• Anti‑deficiency statutes: Completely bar deficiency judgments after foreclosure of certain loans (often purchase money loans on owner‑occupied dwellings).
• Fair‑value statutes: Limit the deficiency to the difference between the debt and the fair market value of the property, not the actual (possibly depressed) sale price.
• Nonrecourse loans: By contract, some mortgages are nonrecourse; the lender’s only remedy is foreclosure, with no deficiency allowed.

On the MBE, assume that a deficiency judgment is available unless the problem tells you about a specific statutory or contractual limit.

Consumer protection defenses

Modern consumer protection statutes give mortgagors additional defenses, which indirectly limit mortgagee remedies:

• Ability‑to‑repay requirements (Dodd‑Frank): Residential mortgage lenders must verify the borrower’s ability to repay. Violations can be raised as defenses or counterclaims in foreclosure.
• Anti‑steering rules: Lenders and brokers may not steer borrowers into loans not in their interest to increase lender compensation.
• Loss‑mitigation/Good‑faith modification rules: For certain federally regulated mortgages, the lender must consider reasonable modification requests and may be temporarily barred from foreclosing while a complete application is pending.

Choice‑of‑law clauses cannot evade these protections where the property is located in a state with stricter foreclosure consumer protection laws; the law of the situs generally governs mortgages.

Additional Exam Points on Mortgagee Remedies

• A mortgagee can usually choose to sue on the note without foreclosing, foreclose, or do both, unless state law requires an election of remedies.
• The mortgagee cannot contractually strip the mortgagor of the equity of redemption at the time the mortgage is created; such “clogging” clauses are unenforceable.
• A deed in lieu of foreclosure, entered into after default, is typically valid and gives the mortgagee clear title subject to any senior liens but does not eliminate junior liens unless they agree.

Worked Example 1.4

Owner borrows $300,000 from Bank, secured by a mortgage on Owner’s home. The mortgage is a purchase money mortgage. Owner defaults; Bank conducts a nonjudicial foreclosure sale under a power‑of‑sale clause. The sale brings $250,000. A state statute provides that no deficiency judgment may be obtained after nonjudicial foreclosure of a purchase money mortgage on an owner‑occupied residence. Can Bank obtain a deficiency?

Answer:
No. Although the sale produced $50,000 less than the loan amount, the anti‑deficiency statute bars any deficiency judgment in this situation. Bank’s sole remedy is the foreclosure sale proceeds.

Exam Warning

On the MBE, pay close attention to:

• Who is foreclosing (senior or junior mortgagee), and in what order the interests were created and recorded. Only junior interests to the foreclosing mortgage are wiped out.
• Whether the mortgagee has transferred the note, the mortgage, or both. If only the mortgage is transferred, the assignment may be ineffective. If only the note is transferred, the mortgage follows automatically.
• Whether the note is negotiable and whether the mortgagor had notice of any assignment when making payments.

Revision Tip

When analyzing a mortgage priority and foreclosure problem:

• Determine priority by the order of recording, subject to:

  • Recording act rules
  • Purchase money mortgage priority
  • Subordination agreements
  • Rules for future advances

• Then determine which mortgage is being foreclosed and apply the rule that foreclosure wipes out properly joined juniors but leaves seniors in place.

Key Point Checklist

This article has covered the following key knowledge points:

• The mortgage secures the note; transfer of the note normally carries the mortgage with it, but transfer of the mortgage alone is often ineffective.
• A transferee who becomes a holder in due course of a negotiable note takes free of most personal defenses and can foreclose the mortgage.
• The mortgagor has an equity of redemption that cannot be waived in advance; clauses that “clog” redemption are invalid.
• Foreclosure is a forced sale that eliminates junior but not senior interests, provided junior interests are properly joined.
• In lien theory states, the mortgagee has no right to pre‑foreclosure possession; in title or intermediate title states, possession after default may be allowed.
• Courts may appoint a receiver to collect rents and protect the security during foreclosure proceedings.
• Priority among mortgages is generally determined by recording order, but purchase money mortgages, future advance mortgages, and subordination agreements can change the result.
• Foreclosure sale proceeds are distributed to sale costs, the foreclosing mortgagee, junior lienors, and then the mortgagor; shortfalls may give rise to a deficiency judgment, subject to statutory and contractual limitations.
• Consumer protection statutes (e.g., Dodd‑Frank ability‑to‑repay rules) provide defenses in foreclosure and may restrict a mortgagee’s remedies.

Key Terms and Concepts

• Mortgagee
• Promissory Note
• Assignment of Mortgage
• Holder in Due Course
• Lien Theory
• Title Theory
• Intermediate Title Theory
• Waste
• Equity of Redemption
• Deed in Lieu of Foreclosure
• Foreclosure
• Power of Sale
• Receiver
• Junior Interest
• Senior Interest
• Purchase Money Mortgage
• Future Advances
• Deficiency Judgment