PastPaperHero | Mortgages/security devices - Payment (including prepayment)

Learning Outcomes

This article explains the rules governing payment of mortgages and security devices, including:

The nature of the mortgagor’s personal obligation on the note and the in rem security interest in the property.
When and how a borrower may prepay, and the enforceability and limits of prepayment penalties.
How acceleration clauses and due-on-sale clauses operate and affect payment obligations.
The effect of payment, tender, and redemption on foreclosure and discharge of the mortgage.
Common MBE pitfalls involving payment to the wrong party, invalid penalties, and defenses based on consumer protection rules.
How transfers of the mortgaged property (assumption vs taking subject to) affect who must pay and who is liable after foreclosure.
How negotiable versus nonnegotiable notes affect who is entitled to payment and which defenses the borrower may assert.
How deficiency judgments, anti-deficiency statutes, and one-action rules influence the lender’s ability to collect after foreclosure.

MBE Syllabus

For the MBE, you are required to understand the legal framework for payment and prepayment of mortgages and security devices, with a focus on the following syllabus points:

The borrower's obligation to pay the mortgage debt and the consequences of default.
The enforceability of prepayment by the borrower and the effect of prepayment penalties.
The operation and effect of acceleration clauses.
The impact of payment and prepayment on foreclosure and the lender's remedies.
The rights and limits of the mortgagor and mortgagee regarding payment, prepayment, and discharge.
The effect of assignment of the note or mortgage on who is entitled to payment.
Defenses and consumer-protection limits on foreclosure based on improper lending or servicing practices.
The effect of transfer of the mortgaged property (assumption vs subject-to) on personal liability, redemption, and deficiency exposure.
The difference between negotiable and nonnegotiable notes for payment, discharge, and 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.

Which of the following is generally true about a borrower's right to prepay a mortgage at common law in the absence of any statute?
1. The borrower may prepay at any time without restriction.
2. The borrower may prepay only if the mortgage or note expressly allows it.
3. Prepayment is always prohibited by law.
4. Prepayment automatically discharges all liens on the property.
What is the primary legal effect of an acceleration clause in a mortgage note?
1. It allows the lender to demand immediate payment of the entire debt upon default.
2. It prohibits the borrower from making any prepayments.
3. It requires the lender to accept partial payments after default.
4. It automatically releases the mortgage upon partial payment.
If a mortgage contains a prepayment penalty clause, which of the following is most accurate?
1. The penalty is always unenforceable.
2. The penalty is enforceable if it is reasonable and not contrary to law.
3. The penalty is enforceable only if the borrower is in default.
4. The penalty applies only to commercial mortgages.
A borrower gives a nonnegotiable note and mortgage to Bank. Bank later assigns the note and mortgage to Lender, but the borrower has no notice of the assignment. The borrower then pays the full balance to Bank. Which is most accurate?
1. The payment is ineffective; the borrower still owes Lender.
2. The payment is effective; Lender’s recourse is against Bank.
3. The payment is ineffective unless Bank forwards the funds to Lender.
4. The payment discharges the note but not the mortgage.
Owner sells Blackacre to Buyer. The deed states that Buyer “assumes and agrees to pay” the existing mortgage. Buyer later defaults, the property is foreclosed, and the sale leaves a deficiency. Which of the following is most accurate regarding personal liability?
1. Only Owner is personally liable; Buyer is never liable on a preexisting mortgage.
2. Only Buyer is personally liable; Owner is completely discharged by the assumption.
3. Both Owner and Buyer are personally liable, but Buyer is primarily liable and Owner is in the position of a surety.
4. Neither Owner nor Buyer is personally liable once a foreclosure sale occurs.

Introduction

A mortgage or similar security device secures repayment of a loan with an interest in real property. Mortgage questions on the MBE often turn on who must pay, when they must pay, whether early payment is allowed, and how default changes what must be paid. Understanding payment, prepayment, acceleration, and discharge is critical to analyzing foreclosure fact patterns and deficiency issues.

Key Term: Mortgage
A security interest in real property given to secure repayment of a debt, typically evidenced by a promissory note.

Key Term: Promissory Note
The borrower’s written promise to repay the loan, stating principal, interest, and payment terms, usually secured by a mortgage or deed of trust on real property.

On the MBE, the term “mortgage” is usually used broadly to include deeds of trust and similar devices. For payment and prepayment issues, you can assume that all such devices operate in the same basic way: the note creates a personal obligation, and the mortgage (or deed of trust) creates a lien on the land to secure that obligation.

Payment obligations arise primarily from the note, while the mortgage gives the lender a remedy against the land if the note is not paid. The note and mortgage usually cross-reference each other, and MBE questions frequently require you to separate the personal obligation from the security interest and to track how both respond to payment, prepayment, default, and transfer of the property.

The examiners also test how mortgage payment rules interact with related doctrines, such as assumption of mortgages by grantees, due-on-sale clauses, rights to redeem after default, and consumer protection rules limiting foreclosure and collection practices. Each of these topics ultimately comes back to a core set of questions:

What must the borrower (or a transferee) pay?
To whom must payment be made?
When and how can the lender demand full payment?
What happens if the borrower tenders payment and the lender refuses?
How does payment or prepayment affect foreclosure and deficiency judgments?

Keeping those questions in mind will help organize your analysis in multi-issue MBE fact patterns.

Payment Obligations Under a Mortgage

The borrower (mortgagor) is obligated to pay the principal and interest according to the terms of the note and mortgage. Typical obligations include:

Paying periodic installments of principal and interest, usually monthly.
Paying taxes and insurance (often into an escrow account administered by the lender or servicer).
Maintaining the property and avoiding waste.
Complying with covenants such as maintaining hazard insurance and not transferring the property without consent if a due-on-sale clause is present.
Paying any late fees or default interest legitimately imposed under the note.

Failure to pay as agreed, or to comply with other material covenants, is a default, which may trigger the lender’s remedies, including acceleration and foreclosure.

Because the mortgage is only security for the note, the starting point in any payment analysis is:

Is the borrower personally liable on the note?
Unless the loan is expressly nonrecourse, the borrower is personally liable for the debt, so the lender can sue on the note, foreclose, or both.
Is there anyone else personally liable?
If a grantee of the property assumes the mortgage, the grantee becomes primarily liable and the original mortgagor becomes a surety, but the lender can usually sue either party.
What is the relationship between the note and the mortgage?
The mortgage “follows” the note. A transfer of the note normally carries the mortgage with it, and a discharge of the note typically discharges the mortgage.

If the debt obligation is unenforceable (for example, because of fraud, failure of consideration, duress, mistake, or incapacity), the mortgage securing that obligation is likewise unenforceable. Defenses to payment on the note are generally defenses to foreclosure.

Key Term: Nonrecourse Loan
A loan in which the borrower has no personal liability; the lender’s only remedy for nonpayment is to foreclose on the collateral.

In most residential mortgage questions on the MBE, assume the loan is recourse unless the facts clearly state otherwise. For a recourse loan:

The lender may sue on the note (an in personam action) to obtain a money judgment.
The lender may foreclose the mortgage (an in rem action) to reach the land.
In many jurisdictions, the lender may do both, either simultaneously or sequentially, subject to any one-action or anti-deficiency statutes that may be mentioned in the fact pattern.

Some states have:

One-action rules – requiring the lender to bring only one action, usually foreclosure, to recover on the debt.
Anti-deficiency statutes – barring or limiting deficiency judgments after foreclosure, particularly for purchase-money mortgages on owner-occupied homes.

These statutory limits are jurisdiction-specific. On the MBE, they will be stated in the facts if relevant; otherwise, assume the lender may pursue both foreclosure and a deficiency judgment for any remaining unpaid debt.

Key Term: Deficiency Judgment
A personal judgment against a mortgagor (or other liable party) for the unpaid balance of the debt after foreclosure proceeds are applied.

If a foreclosure sale brings in less than the debt (including interest, costs, and allowable fees), the lender may seek a deficiency judgment against any party personally liable on the note, unless barred by statute or agreement. If the property sells for more than the debt, the surplus goes to junior lienholders in order of priority and then to the mortgagor.

How Payments Are Applied

Although rarely the central issue in an MBE question, understanding how payments are applied helps evaluate whether a borrower is in default and how much is owed:

Absent contrary agreement, payments are usually applied first to:
- Accrued interest,
- Then to principal,
- Then to late fees and costs.
Parties can agree to a different application (for example, late charges first), but unusual provisions may trigger consumer-protection concerns if they are not clearly disclosed.
If the borrower makes partial payments after default:
- The lender may accept them without waiving the right to accelerate, if the documents say so.
- If the lender routinely accepts late or partial payments without objection, it may be found to have waived strict performance unless there is a clear nonwaiver clause and reasonable notice is given before enforcing strict compliance again.

Personal Liability and Multiple Obligors

Frequently, more than one party is potentially liable on the mortgage debt:

Co-borrowers who both sign the note are jointly and severally liable; the lender may sue either or both for the full amount.
A later purchaser who assumes the mortgage may become primarily liable, while the original mortgagor becomes secondarily liable as a surety.
A later purchaser who takes the property subject to the mortgage is not personally liable; the original mortgagor remains fully liable.

Key Term: Assumption
An agreement by a grantee of mortgaged property to become personally liable for the existing mortgage debt, usually expressed in the deed or a separate writing.

Key Term: Subject-to Mortgage
A transfer of mortgaged property in which the grantee does not agree to be personally liable for the mortgage debt; the land remains encumbered, but only the original mortgagor is liable on the note.

When a grantee assumes an existing mortgage:

The grantee is primarily liable to the lender.
The original mortgagor becomes a surety. The lender can sue either party, but if the mortgagor is forced to pay, they have a right of reimbursement from the assuming grantee.
The lender is typically treated as a third-party beneficiary of the assumption agreement, so it may enforce that promise directly.
If the lender and assuming grantee later modify the loan in a way that materially increases the risk to the original mortgagor (for example, by increasing the interest rate or principal or extending the term in a way that increases total interest), the mortgagor may be discharged as a surety, at least to the extent of the modification.

When a grantee takes the property subject to the mortgage:

The lender cannot sue the grantee personally on the note.
The lender can still foreclose on the property if the debt is not paid.
The original mortgagor remains fully liable for any deficiency unless otherwise released.
The grantee effectively “bets” its equity in the property: if payments are not made, foreclosure may wipe out the grantee’s investment.

On the MBE, pay careful attention to the language in the deed:

“Grantee assumes and agrees to pay the existing mortgage” indicates an assumption.
“Conveyed subject to the existing mortgage” ordinarily means no personal liability on the grantee.
Mere knowledge of the mortgage is not enough; there must be an actual assumption agreement for personal liability to arise.

Suretyship principles can generate exam issues:

If the lender releases the assuming grantee without the consent of the original mortgagor, the mortgagor may be discharged to the extent of the release.
If the lender impairs collateral (for example, by failing to pay property taxes out of escrow, allowing a tax lien to prime the mortgage), the mortgagor-surety may claim discharge or reduction of liability.

Payment, Tender, and the Effect on Interest and Costs

Key Term: Tender
An unconditional offer by the debtor to pay the amount due. If a proper tender is wrongfully refused, it can affect the accrual of interest, liability for costs, and the lender’s right to foreclose.

For a tender of payment to be legally effective:

It must be for the correct amount due:
- All matured principal and interest,
- Any late fees, escrow shortages, and other charges that are properly due under the note and mortgage,
- If the loan has been validly accelerated, the full accelerated balance plus permissible fees and costs (unless reinstatement is allowed; see below).
It must be unconditional:
- The borrower cannot condition payment on terms the lender has no obligation to accept (e.g., “I will pay if you agree never to foreclose again”).
- Reasonable conditions tied to calculating the payoff (like requesting a payoff statement) do not invalidate tender.
It must be made at the proper time:
- On or before the date payments are due, or
- Before the foreclosure sale, if the borrower seeks to exercise equitable redemption.

Tender must also be made to the correct party (the person entitled to enforce the note). If the borrower tenders to someone with no right to receive payment, the lender can treat the payment as ineffective, and the borrower may remain in default.

If the lender wrongfully refuses a proper tender:

Interest may stop accruing from the date of tender, because the borrower has done all that is required.
The lender may be denied some or all costs of foreclosure.
In some jurisdictions, a wrongful refusal may bar foreclosure altogether if the borrower remains ready, willing, and able to pay, although this depends on local law.
The borrower may pay the amount into court (an interpleader or similar deposit), strengthening the argument that the obligation has been satisfied.

However, a tender for less than what is due—such as only the arrearages after valid acceleration—generally does not stop foreclosure unless the borrower has a contractual or statutory right to reinstate on those terms.

For exam purposes:

Distinguish between:
- Tender to cure default (often arrearages plus fees), and
- Tender to redeem (full debt, often after acceleration).
Ask whether a statute or loan provision gives a right to reinstate by paying only arrearages. Without such a right, the lender can insist on the full accelerated amount.

Prepayment of Mortgages

Borrowers sometimes wish to pay off their mortgage early—for example, when selling the property or refinancing at a lower interest rate. The right to prepay is not automatic.

At common law, a borrower could not prepay unless the mortgage or note expressly allowed it. The lender could insist on receiving all scheduled interest payments over the full term. Modern practice varies by jurisdiction and by loan type, but for MBE purposes you should generally assume:

There is no right to prepay unless:
- The note or mortgage expressly allows prepayment; or
- A statute gives the borrower that right (especially in consumer residential loans).

If the documents are silent, the lender may refuse early payment and continue to collect installments. That is the rule the examiners typically apply unless the facts mention a statute providing a prepayment right.

Key Term: Prepayment
The act of paying off all or part of a mortgage loan before it is due under the terms of the note.

Prepayment can take several forms:

Full prepayment – paying the entire remaining balance of principal (and any interest due to the payoff date), usually to sell the property or refinance.
Partial prepayment (curtailment) – paying extra principal in addition to scheduled installments, which reduces the outstanding balance and future interest.
Prepayment upon sale – paying off the loan from sale proceeds at closing, often required by due-on-sale clauses or by payoff demands from the lender.

The loan documents might:

Grant an unrestricted right to prepay without penalty.
Allow prepayment only after a certain date or only with the lender’s consent.
Allow partial prepayment but limit the number or size of extra payments.
Prohibit any prepayment prior to maturity (more common historically or in commercial loans).

On the MBE, always look for explicit prepayment language and apply it as written unless a statute in the problem overrides it.

Statutory and Consumer-Protection Limits

Modern consumer-protection statutes (often for owner-occupied residential loans) commonly:

Give borrowers a statutory right to prepay without penalty after a certain number of years or at least cap the size of any penalty.
Restrict or prohibit prepayment penalties on certain high-cost loans or subprime mortgages.
Require clear, conspicuous disclosure of any prepayment restrictions and charges.
Sometimes require the lender to allow prepayment at any time, with at most a modest charge.

If the facts mention such a statute or regulation, treat it as controlling even if the contract says otherwise. A contract clause conflicting with a specific statutory consumer-protection rule will generally be unenforceable.

Why Prepayment Matters in Exam Questions

Prepayment issues often appear on the MBE in combination with:

Sales and refinancing:
- A buyer or new lender needs the old mortgage paid off and the lien released.
- The seller may face a prepayment penalty or be barred from prepaying if the documents so provide (absent statute).
Due-on-sale clauses:
- The existing lender uses a due-on-sale clause to demand payoff when the property is sold.
- The borrower may try to avoid payoff by having the buyer assume the mortgage; the clause may prevent this.
Interest-rate changes:
- A borrower wants to refinance when market rates drop; the old lender may rely on prepayment penalties to recoup its expected interest income.
Balloon payments:
- A loan may require a final large payment (a balloon) earlier than the amortization schedule would suggest. Borrowers may confuse balloon payments with prepayment, but for exam purposes, a balloon payment is a scheduled payment and not prepayment.

In these contexts, determine:

Whether the borrower has a contractual or statutory right to prepay.
Whether a prepayment penalty applies and is enforceable.
Whether prepayment will fully discharge the lien (it normally will, once the payoff amount is properly calculated and paid).

Prepayment Penalties

Many mortgages, especially commercial ones, include a prepayment penalty clause. This clause requires the borrower to pay an additional fee if the loan is paid off early, typically calculated as:

A percentage of the outstanding balance (e.g., 2% of the remaining principal); or
A specified number of months of interest (e.g., six months’ interest) on the amount prepaid; or
A “yield maintenance” formula designed to protect the lender’s expected yield.

Key Term: Prepayment Penalty
A contractual fee charged by the lender if the borrower pays off the mortgage before maturity, intended to compensate the lender for lost interest and related costs.

Courts generally enforce prepayment penalties if they are:

Reasonable in amount, functioning as a form of liquidated damages rather than a punitive penalty.
Clearly disclosed and agreed to in the note or mortgage.
Not prohibited or restricted by statute (many states and federal laws limit penalties in consumer residential mortgages).

Excessive or punitive penalties may be invalidated as:

An unenforceable penalty rather than a valid liquidated-damages clause.
A disguised restraint on alienation if they effectively prevent the borrower from selling or refinancing the property.
Contrary to consumer-protection statutes (for example, high-cost loan regulations).

Reasonableness is typically evaluated with reference to:

The lender’s expected loss of interest over the remaining term.
The time value of money and likelihood of reinvesting at comparable rates.
Customary industry practices for similar loans.
Whether the penalty declines over time (a “step-down” penalty is more likely to be upheld than a flat penalty that persists for the entire term).

Some jurisdictions also limit collection of a prepayment penalty after the lender has accelerated the debt, reasoning that once the lender has chosen to demand immediate payment, collecting a “prepayment” charge is inconsistent. Unless the facts give you a specific statute or rule, the MBE tends to treat reasonable prepayment penalties as enforceable even after acceleration if the contract clearly so provides.

However, exam questions may include subtle variations:

If the borrower voluntarily prepays before default (e.g., by refinancing), the penalty is more likely enforceable.
If prepayment is the result of involuntary events (such as condemnation or casualty destroying the property), a court might refuse to enforce the penalty unless the contract clearly covers such circumstances.
If a statute bars penalties in certain circumstances (for example, prepayment made after a specified number of years), any contractual penalty conflicting with that statute will be invalid.

When analyzing an MBE question:

Identify whether the penalty is triggered (e.g., prepayment before a certain date or within a specified period).
Determine if any statute mentioned in the facts either forbids the penalty or caps its amount.
Consider whether the lender’s attempt to collect the penalty is consistent with its other actions (such as acceleration due to default) and with the contract language.

Acceleration Clauses

Most mortgages and notes contain an acceleration clause. This clause allows the lender to declare the entire loan balance due immediately upon the borrower’s default, such as missing a payment, failing to pay taxes, committing waste, or breaching another covenant.

Key Term: Acceleration Clause
A provision in a loan agreement that permits the lender to demand immediate payment of the entire outstanding balance upon the occurrence of a specified event, usually default.

Key points for the MBE:

Optional vs. automatic acceleration:
- Most clauses give the lender the option to accelerate. The lender must take some affirmative step (e.g., sending a notice of acceleration or filing a foreclosure action) before the full balance becomes due.
- If the clause instead provides for automatic acceleration upon a specified event (for example, “this note shall automatically become due if the borrower fails to pay taxes”), no further action is needed once that event occurs.
Effect of acceleration:
- After valid acceleration:
  - The entire unpaid principal, plus accrued interest, late fees, and allowable costs, becomes due.
  - The borrower is no longer entitled to cure the default merely by paying the past-due installments unless the loan documents or a statute grant a right to reinstate.
  - The statute of limitations on an action to enforce the note may begin to run on the entire debt.
Conditions for valid acceleration:
- The lender must comply with any contractual conditions precedent to acceleration, such as:
  - Giving written notice of default.
  - Allowing a specified cure period.
  - Stating that failure to cure will result in acceleration.
- The lender must act in good faith and not accelerate for trivial or pretextual breaches if the clause or governing law so requires.

On the MBE, if the lender fails to follow these procedural requirements, acceleration (and a foreclosure based solely on it) may be improper. A borrower can then argue that only the missed payments are due, not the full balance.

Waiver and Acceptance of Late Payments

Lender behavior after default can affect its ability to accelerate:

If a lender repeatedly accepts late payments without objection, a court might find:
- A waiver of the right to insist on strict punctuality; or
- An implied requirement that the lender give reasonable notice before enforcing strict compliance and accelerating.
Many mortgage forms include a nonwaiver clause stating that acceptance of late payments does not waive the right to accelerate in the future.
- On the MBE, the presence of a clear nonwaiver clause usually favors the lender and allows acceleration despite prior leniency.
- Extreme or longstanding indulgence may still lead to a finding of waiver or estoppel in some jurisdictions, but unless the facts emphasize unconscionable conduct, assume the nonwaiver clause is effective.

Interaction with Prepayment and Penalties

Acceleration changes the nature of the borrower’s obligation:

Before acceleration, a borrower who wants to pay off the loan early is prepaying; any contractual prepayment penalty may apply.
After acceleration, the entire balance is due. If the borrower then pays in full, the issue is whether that payment is still “prepayment” triggering a penalty.

Jurisdictions differ, but on the exam:

If the clause clearly imposes a charge upon any early payoff, including after acceleration, it is likely enforceable unless barred by statute or treated as an unenforceable penalty.
If the clause is ambiguous, many courts construe it against the lender and disallow the penalty once the lender has accelerated.
Some courts reason that once the lender accelerates, the maturity date is effectively advanced; payment is no longer “early” and thus is not a prepayment.

Analyzing a fact pattern:

Determine whether the lender has actually accelerated (and properly).
Check the timing of any prepayment penalty clause and how it defines a “prepayment.”
Apply any statutory or case-law rule provided in the problem.

Due-on-Sale Clauses

Acceleration is not only triggered by missed payments. Many modern mortgages also accelerate when the property is transferred.

Key Term: Due-on-Sale Clause
A mortgage provision allowing the lender to demand immediate payment of the full debt if the mortgagor transfers any interest in the property without the lender’s consent.

Due-on-sale clauses serve to:

Protect the lender from an unknown or weaker credit risk.
Allow the lender to reset the interest rate if rates have risen.
Prevent informal assumptions or wraparound financing that deprive the lender of control and expected returns.

On the MBE:

Assume due-on-sale clauses are generally enforceable, subject to specific statutory limits that will be stated if relevant.
A sale in violation of a due-on-sale clause typically constitutes a default that allows acceleration and foreclosure, even if the regular installments are current.
Most modern institutional mortgages include such clauses; the absence of one is unusual and may be mentioned explicitly.

Federal law (the Garn–St. Germain Depository Institutions Act) broadly authorizes enforcement of due-on-sale clauses by many institutional lenders and preempts most state law restrictions, but mandates certain exceptions (e.g., transfers:

To a surviving joint tenant,
To a spouse or child upon the borrower’s death,
Incident to divorce,
Into certain inter vivos trusts in which the borrower remains a beneficiary).

Details of Garn–St. Germain are unlikely to be tested in depth unless explicitly mentioned.

From a payment standpoint:

If the lender waives the due-on-sale clause and permits an assumption:
- It may charge an assumption fee or adjust the interest rate, as permitted by contract and law.
- The assuming grantee may become personally liable, changing who must pay and who faces deficiency exposure.
If the lender enforces the clause:
- The mortgagor or any assuming grantee must either pay off the loan in full (including any lawful prepayment penalty) or face foreclosure.
- The clause effectively forces payoff upon sale, making prepayment rights and penalties central to the transaction.

Payment to the Proper Party After Transfer of the Note

Payment must be made to the person entitled to enforce the note. This can create issues when the original mortgagee transfers the note or mortgage to another party.

Key Term: Holder
A person in possession of a negotiable instrument that is payable either to bearer or to that person, and who is thus entitled to enforce it under the UCC.

Key Term: Holder in Due Course
A holder who takes a negotiable instrument for value, in good faith, and without notice of certain defenses or claims; such a holder is insulated from most personal defenses the maker might otherwise assert.

Under the version of the UCC enacted in most states (UCC § 3-602):

If the note is negotiable and the original payee transfers possession of it to another person, payment to the original payee does not discharge the borrower’s obligation. The borrower must pay the current holder of the note. The risk of paying the wrong party is on the borrower.
A “person entitled to enforce” the note is typically:
- The holder (in possession of the note payable to bearer or to that person), or
- A nonholder in possession who has the rights of a holder (e.g., through assignment).

For nonnegotiable notes, the modern rule (Restatement (Third) of Property: Mortgages § 5.5) is different:

If the original mortgagee transfers a nonnegotiable note and mortgage:
- Payment to the original mortgagee is effective against the transferee until the mortgagor receives notice of the transfer.
- After the mortgagor receives notice, payment must be made to the transferee, and payment to the original mortgagee will no longer discharge the debt.

This Restatement rule allocates to the transferee the burden of notifying the borrower of the transfer.

Key Term: Satisfaction of Mortgage
The act (and often the recorded document) by which a mortgagee acknowledges that the mortgage debt has been paid in full and releases the lien on the property.

MBE tip:

If the fact pattern mentions a negotiable instrument and a “holder,” suspect that the UCC rule applies and payment to the original payee will not discharge the debt.
If the problem emphasizes that the note is nonnegotiable and the borrower lacked notice of the assignment, payment to the original mortgagee will usually be effective, and the assignee’s remedy is against the assignor.

Payment to the wrong person also affects defenses:

A person who qualifies as a holder in due course (HDC) takes the note free of many personal defenses the borrower might have against the original lender, such as:
- Failure of consideration,
- Ordinary fraud in the inducement,
- Waiver or estoppel,
- Certain misrepresentations.
An HDC is still subject to real defenses, including:
- Infancy,
- Incapacity,
- Duress,
- Illegality (if the law renders the obligation void),
- Fraud in the execution (fraud in factum),
- Forgery,
- Discharge in insolvency (bankruptcy),
- Other discharge of which the HDC has notice.

If the transferee is not an HDC (for example, because it takes with notice of defenses or after default), the borrower may assert any defense against the transferee that would be available against the original payee.

For payment analysis:

The borrower must identify who is entitled to enforce the note.
If the borrower pays someone else, the payment may or may not discharge the obligation depending on negotiability and notice.
A recorded assignment of mortgage does not automatically give constructive notice of the assignment of a nonnegotiable note for UCC purposes, but exam facts will usually state whether notice was given.

Effect of Prepayment After Acceleration

If the lender accelerates the debt, the borrower’s obligations change significantly.

If the lender accelerates the debt, the borrower may still avoid foreclosure by paying the full accelerated amount (plus any lawful penalties, interest, and costs) before foreclosure. This payment is both:

A redemption of the property (equitable redemption), and
Satisfaction of the accelerated debt.

However, if the note prohibits reinstatement and the borrower tenders only the missed installments, the lender may continue with foreclosure.

Key Term: Equitable Redemption
The mortgagor’s right, before a valid foreclosure sale, to recover the property by paying off the mortgage debt, typically including accrued interest, costs, and any properly incurred fees.

Key Term: Reinstatement
The mortgagor’s curing a default and undoing acceleration by paying past-due amounts, interest, and costs, thereby restoring the loan to its original schedule when the contract or a statute permits.

Two distinct rights appear in MBE fact patterns:

Reinstatement (curing the default):
- Some states and loan documents give the borrower a right to end the default and cancel acceleration by paying only the arrearage plus fees and costs, rather than the full accelerated balance.
- This is a contractual or statutory right; there is no general common-law right to reinstatement.
- Reinstatement is often allowed up to a certain time before the scheduled foreclosure sale (e.g., up to five days before).
- If the borrower properly reinstates, the loan returns to its original schedule, and foreclosure must be halted.
Equitable redemption:
- Even without a reinstatement right, a borrower usually has the equitable right to redeem the property by paying the entire accelerated debt before the foreclosure sale.
- After a valid foreclosure sale, equitable redemption is cut off.
- Tender must include:
  - All unpaid principal,
  - Accrued interest,
  - Allowable costs and fees,
  - Any valid prepayment penalty if applicable after acceleration (depending on jurisdiction and contract).

Key Term: Statutory Right of Redemption
A post-foreclosure right created by statute in some states allowing the mortgagor to regain title within a fixed period by paying the amount required by statute (often the sale price plus costs and interest).

Some states also give the mortgagor a statutory right of redemption after the foreclosure sale. The MBE will tell you if such a statute applies; otherwise, assume that once a valid foreclosure sale occurs, only any statutory right (if stated) remains.

Key payment consequences of acceleration:

The borrower cannot insist on partial payments after acceleration unless a reinstatement right exists.
Tender of the full accelerated amount (and lawful fees) before sale must be accepted and will stop foreclosure.
If the lender wrongfully refuses a proper tender of the full amount, the borrower may have a complete defense to foreclosure and may stop the accrual of further interest and fees.

From a practical exam standpoint, distinguish carefully between:

A borrower offering to pay only the missed installments plus fees (reinstatement).
A borrower offering to pay the full outstanding principal and interest (redemption).

The first will stop foreclosure only if a reinstatement right exists; the second must be accepted if made before a valid sale.

Discharge of the Mortgage

Full payment of the debt (including any lawful prepayment penalties, interest, and costs) discharges the mortgage, and the lender must release its security interest. If the borrower tenders proper payment and the lender refuses to accept it, the borrower may have a defense to foreclosure and may seek declaratory or injunctive relief.

Key Term: Discharge of Mortgage
Termination of the mortgage lien, typically upon full satisfaction of the secured obligation, so that the real property is no longer encumbered by that mortgage.

A mortgagee’s right to foreclose is precluded by anything amounting to a discharge of the mortgage, such as:

Payment of the debt secured in full (the main focus for the MBE).
Merger of legal and equitable interests (for example, when the mortgagee acquires title to the property and the lien merges into the fee, unless the parties intend otherwise).
Acceptance of a deed in lieu of foreclosure, where the mortgagor conveys the property to the lender in satisfaction of the debt.
Expiration of the statute of limitations on the debt itself (in many jurisdictions, this also bars foreclosure).

Key Term: Deed in Lieu of Foreclosure
A voluntary conveyance of the mortgaged property by the mortgagor to the mortgagee in full or partial satisfaction of the debt, accepted as an alternative to foreclosure.

In practice:

When the loan is paid off, the lender should sign and record a satisfaction or release of mortgage, clearing the public record.
If the lender fails or refuses to release a paid-off mortgage, the borrower can seek equitable relief (e.g., quiet title) and may recover statutory or other damages in some jurisdictions.
For exam purposes, remember that full payment discharges the lien even if the lender has not yet recorded a formal release; the recording affects third-party notice, not the obligation itself.

Discharge can also arise indirectly:

If the lender and borrower modify the loan so extensively that it is effectively a new obligation, the original mortgage may be discharged unless reaffirmed. Some jurisdictions require a new or modified mortgage document to be recorded to secure the modified obligation.
If a third party (such as an assuming grantee or guarantor) pays the debt, the mortgage may be:
- Discharged as to the original lender, but
- Equitably assigned to the paying party, who is subrogated to the lender’s rights and can enforce the mortgage against others (for example, against a nonassuming grantee).
Parties may agree to release the mortgage while leaving the note in place (for instance, substituting other collateral), but that is unusual in MBE questions.

Because a mortgage secures a debt obligation, anything that makes the obligation unenforceable will also block foreclosure. Common defenses include:

Lack or failure of consideration (e.g., the borrower never actually received the loan funds).
Duress or undue influence in signing the note and mortgage.
Fraud or material misrepresentation.
Certain forms of illegality (for example, usury statutes that render the entire debt void).
Incapacity or minority, where applicable.

If the borrower establishes such a defense, the lender cannot collect on the note or foreclose the mortgage.

Modern residential mortgage law also includes significant consumer-protection rules. After the 2008 foreclosure crisis, federal law (including the Dodd–Frank Act) and regulations imposed duties on many residential lenders, such as:

Ability-to-repay requirements (Dodd–Frank):
- Lenders making residential mortgage loans must make a reasonable, good-faith determination that the borrower has the ability to repay.
- The terms of the loan must be understandable and not unfair, deceptive, or abusive.
- The borrower may raise violations of these requirements as a defense to foreclosure.
Anti-steering rules:
- Loan originators generally may not direct borrowers to loans that are not in the borrower’s interest merely to increase the originator’s compensation.
- Steering a borrower to a higher-cost loan when a cheaper, suitable product is available may violate these rules and provide a defense in foreclosure.
Loss-mitigation requirements:
- For some mortgages (e.g., certain federally insured loans), a mortgagee must, in good faith, consider a borrower’s request for modification or other alternatives before foreclosing.
- The mortgagee usually cannot proceed to foreclosure sale while a timely, complete modification application is pending.
- If the lender violates these servicing rules, courts may halt or set aside foreclosure proceedings.

Additionally, the law of the state in which the property is located typically governs mortgage-related issues. Attempts to choose the law of another state to evade consumer-protection rules on foreclosure or prepayment are often ineffective.

A choice-of-law clause selecting the law of a state with weaker consumer protections is generally void as to issues governed by the law of the situs of the real property.
The MBE may state that a particular consumer-protection statute applies to the property; that statute will govern even if the contract says otherwise.

Other possible defenses or limitations that may arise:

Unconscionability:
- If the loan terms are grossly one-sided and the borrower lacked meaningful choice, a court may refuse to enforce some provisions (such as extreme prepayment penalties or default interest rates).
Usury:
- If the interest rate exceeds statutory limits, the lender may forfeit some or all interest or, in extreme cases, part of the principal.
- The effect depends on the specific state statute; the MBE will provide any necessary details.
Improper application of payments:
- If the lender misapplies payments (e.g., allocating payments first to late fees and default charges contrary to contract, causing an artificial default), the borrower may argue that the stated default is invalid.
Procedural defects in foreclosure:
- Failure to give required notices,
- Violations of statutory timelines,
- Noncompliance with contractual cure provisions.

The exam will not require detailed regulatory citations but will expect you to recognize when a described consumer-protection rule clearly applies and to adjust the lender’s ability to demand payment or foreclose accordingly.

Worked Example 1.1

A homeowner takes out a 15-year mortgage loan. The note is silent on prepayment. Five years later, the homeowner wants to pay off the remaining balance in full. The lender refuses, insisting on continuing to collect monthly payments.

Answer:
Unless the note or mortgage expressly allows prepayment, the lender can refuse early payment under the common-law rule. The homeowner has no right to prepay unless the loan documents grant it or state law provides otherwise. On the MBE, absent an express clause or statute in the facts, assume silence means no right to prepay, and the lender may continue to collect according to the original schedule.

Worked Example 1.2

A borrower defaults on a mortgage containing an acceleration clause and a prepayment penalty. The lender accelerates the debt and begins foreclosure. The borrower offers to pay the full amount plus the penalty before the sale.

Answer:
The lender must accept full payment of the accelerated amount (including any reasonable prepayment penalty if enforceable) and release the mortgage, stopping the foreclosure. Tender of the full accelerated balance plus lawful charges is an exercise of equitable redemption. However, if the penalty is unreasonably high or barred by statute, a court may refuse to enforce it. The key is that tender of the full amount due before the sale must be honored; the dispute may only concern whether the penalty portion must be paid.

Worked Example 1.3

Borrower signs a negotiable promissory note payable to Bank and a mortgage on Blackacre. Bank indorses and delivers the note to Investor, who becomes the holder, but Borrower is not notified. Borrower later pays Bank the full amount due, believing Bank still holds the note. Investor then demands payment from Borrower.

Answer:
Because the note is negotiable and Bank transferred possession, Investor is the person entitled to enforce the note under the UCC. Payment to Bank does not discharge Borrower’s obligation. Borrower still owes Investor and bears the loss of paying the wrong party. Borrower might have a claim against Bank for unjust enrichment or conversion, but that does not affect Investor’s rights.

Worked Example 1.4

Same facts as Worked Example 1.3, except the note is expressly nonnegotiable. Bank assigns the note and mortgage to Investor, but Borrower has no notice of the assignment. Borrower then pays Bank in full. Investor demands payment.

Answer:
For a nonnegotiable note, payment to the original mortgagee is effective against a transferee until the mortgagor receives notice of the transfer, under the modern Restatement rule. Borrower’s payment to Bank discharges the obligation. Investor’s remedy is against Bank for the misdirected funds. Once Borrower receives notice of the assignment, however, future payments must be made to Investor.

Worked Example 1.5

A borrower misses three monthly payments. The loan documents contain an optional acceleration clause but also state that the borrower has a right to reinstate up to five days before any foreclosure sale by paying all past-due installments, late fees, and costs. The lender accelerates the debt and begins foreclosure. Two weeks before the sale, the borrower offers to pay only the missed payments plus fees and costs.

Answer:
Because the contract grants a right of reinstatement, the borrower may cure the default and cancel the acceleration by paying the arrearages, fees, and costs within the specified time. The lender must accept this payment and halt the foreclosure. Without such a clause (or a statute providing a reinstatement right), the borrower’s tender of less than the full accelerated balance would not prevent foreclosure, because after acceleration the entire debt is due.

Worked Example 1.6

O borrows $200,000 from Bank, gives Bank a note and mortgage on Blackacre. Five years later, O sells Blackacre to A. The deed states that A takes “subject to” the existing mortgage. O stops making payments and disappears. Bank forecloses; the sale yields$ 150,000, leaving a $40,000 unpaid balance after costs. Bank seeks a deficiency judgment against A.

Answer:
A took the property subject to the mortgage and did not assume the debt, so A has no personal liability on the note. Bank cannot obtain a deficiency judgment against A; its only recourse is against O (and the foreclosure proceeds). The foreclosure can still wipe out A’s equity in Blackacre, but A is not personally liable for the remaining $40,000. This illustrates the distinction between liability on the note (personal) and exposure of the property to the lien (in rem).

Worked Example 1.7

Same initial facts as Worked Example 1.6, except the deed states that A “assumes and agrees to pay” the existing mortgage. Bank later modifies the loan with A, raising the interest rate significantly without notifying O. A defaults. After foreclosure, Bank sues O for a deficiency.

Answer:
When A assumed the mortgage, A became primarily liable and O became a surety. The subsequent modification between Bank and A that materially increased the interest rate increased O’s risk as surety. Under suretyship principles, such a material modification without the surety’s consent discharges O from personal liability. Bank may pursue A for any deficiency but may not recover it from O. On the MBE, look for loan modifications after assumption as a possible basis for discharging the original mortgagor.

Worked Example 1.8

Borrower falls two months behind on a residential mortgage. The note and mortgage require the lender to give a 30-day written notice of default and right to cure before accelerating. The lender immediately files a foreclosure action, declaring the full balance due, without sending the required notice. Borrower offers to pay the two missed payments plus late fees within a week.

Answer:
The lender failed to comply with the contractual condition precedent to acceleration (notice and cure period), so its attempt to accelerate is ineffective. At this point, only the two missed payments plus late fees are actually due. Borrower’s prompt offer to pay those amounts cures the default, and foreclosure or acceleration based on that default should be denied. The lender may not insist on full acceleration where it has not followed its own prescribed procedures.

Worked Example 1.9

Borrower has a 30-year fixed-rate mortgage that expressly allows prepayment “at any time without penalty.” Ten years later, Borrower sells the property. The buyer obtains new financing; the closing agent tenders the full payoff amount to Lender. Lender demands an additional “processing fee” equal to three months of interest before releasing the mortgage.

Answer:
The note explicitly permits prepayment at any time without penalty. Lender’s demand for an extra “processing fee” that is calculated as additional interest is effectively a prepayment penalty inconsistent with the contract language. Because the contract does not authorize this extra charge and instead expressly allows penalty-free prepayment, Borrower (or the closing agent) need only pay the actual payoff balance (principal plus accrued interest to the payoff date). The mortgage must be released upon that payment. Any attempt to condition release on an unauthorized extra payment is improper and would not be enforced on the MBE.

Worked Example 1.10

Borrower signs a residential mortgage governed by a state statute that: (i) gives Borrower a right to prepay without penalty after five years, and (ii) requires the lender to consider in good faith any timely application for loan modification before foreclosure. Seven years later, Borrower loses her job and misses three payments. She promptly applies for a modification. The lender ignores the application, accelerates the loan, and begins foreclosure. Borrower then tenders the full principal balance and accrued interest but refuses to pay the prepayment penalty specified in the note. The lender rejects the tender and proceeds to sale.

Answer:
The statute gives Borrower an unqualified right to prepay without penalty after five years, so the contractual prepayment penalty is unenforceable at the time of tender. Borrower’s tender of the full principal and accrued interest therefore constitutes a proper tender of the amount due. The lender’s refusal is wrongful. In addition, the statute requires the lender to consider in good faith Borrower’s timely modification request before foreclosing; ignoring the request violates that duty and makes the foreclosure improper. On these facts, Borrower has strong defenses: the debt is effectively satisfied by tender, the penalty is invalid, and foreclosure should be barred or set aside.

Exam Warning

Prepayment penalties are generally enforceable if reasonable and consistent with statutes, but excessive penalties may be struck down as an unlawful restraint on alienation or as a penalty rather than liquidated damages. Always check if the penalty is proportionate to the lender’s probable loss and not contrary to any consumer-protection statute in the fact pattern. Also pay close attention to whether the note is negotiable or nonnegotiable and whether the borrower had notice of any assignment; this determines whether payment to the original mortgagee discharges the debt.

Another common trap concerns assumption and subject-to language in deeds. Do not assume that a grantee is personally liable just because the grantee knows about the mortgage or continues to make payments. Only an explicit assumption agreement creates personal liability; otherwise, the grantee’s risk is limited to losing the property in foreclosure. Similarly, do not forget that modifications between the lender and an assuming grantee can discharge the original mortgagor if they materially increase the risk to that mortgagor as surety.

Revision Tip

Always check the loan documents for express prepayment terms, penalties, acceleration clauses, due-on-sale clauses, and any reinstatement rights. Do not assume prepayment is allowed unless clearly stated, and do not assume that partial payment after acceleration will cure the default unless the contract or a statute gives a right to reinstate. In transfer problems, identify precisely who is personally liable on the note and who merely owns the property subject to the lien. In assignment problems, determine whether the note is negotiable and who is entitled to enforce it so you can decide whether payment to a given party discharges the obligation.

Key Point Checklist

This article has covered the following key knowledge points:

The borrower’s obligation to pay the mortgage debt is governed by the terms of the note and mortgage.
Defenses to the debt obligation (e.g., fraud, duress, failure of consideration, illegality, incapacity) are also defenses to foreclosure.
Prepayment is not a right unless expressly allowed by the loan documents or required by statute; silence usually means no right to prepay at common law.
Prepayment penalties are enforceable if reasonable, clearly agreed upon, and not contrary to law or public policy; excessive or undisclosed penalties may be invalid.
Acceleration clauses allow the lender to demand full payment upon specified events, usually default or unauthorized transfer, but the lender must satisfy any contractual conditions precedent to acceleration.
After acceleration, the borrower generally must pay the full accelerated amount to redeem, unless a reinstatement right allows cure by paying only arrearages and costs.
Due-on-sale clauses are generally enforceable and allow acceleration when the mortgagor transfers the property without consent, even if payments are otherwise current.
Transfer of the property by the mortgagor may create an assuming grantee (personally liable and primarily responsible) or a nonassuming grantee (no personal liability, but property still subject to the lien).
The original mortgagor who becomes a surety upon assumption may be discharged if the lender later modifies the loan in a way that materially increases the surety’s risk.
Payment must be made to the person entitled to enforce the note; payment to the wrong party may or may not discharge the debt depending on whether the note is negotiable and whether the borrower had notice of an assignment.
For negotiable notes, payment to the original payee after transfer does not discharge the borrower’s obligation; for nonnegotiable notes, payment to the original mortgagee is effective until the borrower has notice of the assignment.
Full payment (including any lawful penalties, interest, and allowed costs) discharges the mortgage and ends the lender’s security interest, even if the lender delays recording a release.
Tender of the proper amount, if wrongfully refused, can stop interest from accruing, may bar or limit foreclosure, and can form the basis for equitable relief.
Consumer-protection rules (such as ability-to-repay, anti-steering, and loss-mitigation requirements) can provide defenses to foreclosure and affect payment obligations, regardless of contrary contract terms.
Choice-of-law clauses selecting the law of a state with weaker foreclosure protections generally cannot override the law of the state where the mortgaged property is located.

Key Terms and Concepts

Mortgage
Promissory Note
Nonrecourse Loan
Deficiency Judgment
Assumption
Subject-to Mortgage
Prepayment
Prepayment Penalty
Acceleration Clause
Due-on-Sale Clause
Tender
Equitable Redemption
Statutory Right of Redemption
Reinstatement
Deed in Lieu of Foreclosure
Satisfaction of Mortgage
Holder
Holder in Due Course
Discharge of Mortgage

Mortgages/security devices - Payment (including prepayment)