Mortgages/security devices - Types

Learning Outcomes

This article explains the primary types of security devices used in real property transactions for bar exam purposes, including:

• distinguishing between legal and equitable mortgages and the role of the accompanying promissory note in each device;
• classifying security arrangements as standard mortgages, purchase money mortgages, deeds of trust, or installment land contracts based on their structure and purpose;
• identifying fact patterns that create an equitable mortgage, such as absolute deeds intended as security, installment land contracts, and sale‑leaseback arrangements;
• comparing lien theory, title theory, and intermediate theory jurisdictions and determining how each theory allocates title, possession, and the right to foreclose;
• evaluating how courts recharacterize transactions that function as security interests and the consequences for equity of redemption, foreclosure requirements, and the availability of deficiency judgments;
• applying these classification and priority rules to MBE‑style hypotheticals to determine who holds title, who may possess the property, and which creditor’s interest prevails after default.

MBE Syllabus

For the MBE, you are required to understand the different devices used to secure an obligation with an interest in real property, with a focus on the following syllabus points:

• Identify the basic components of a mortgage transaction (promissory note and mortgage).
• Distinguish between a legal mortgage and an equitable mortgage.
• Recognize situations creating an equitable mortgage, such as an absolute deed intended as security, an installment land contract, or a sale‑leaseback.
• Understand the nature and function of a deed of trust, including the roles of trustor, trustee, and beneficiary.
• Distinguish a purchase money mortgage from other mortgages and understand its typical priority.
• Differentiate between lien theory, title theory, and intermediate theory states regarding the effect of a mortgage on title and possession.

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. A borrower gives a lender a document that appears to be a deed conveying Blackacre outright to the lender. However, there is strong evidence they orally agreed the borrower could repurchase Blackacre upon repaying a specified sum. How will a court likely treat this transaction?
   1. As a valid absolute conveyance.
   2. As an equitable mortgage.
   3. As a leasehold agreement.
   4. As an invalid transfer due to the Statute of Frauds.
2. Which theory regarding mortgages treats the lender as holding legal title to the property until the debt is satisfied?
   1. Lien theory.
   2. Title theory.
   3. Intermediate theory.
   4. Equitable conversion theory.
3. Seller agrees to sell Buyer Blackacre for $100,000, payable in monthly installments over 10 years. The contract states Seller retains title until the final payment is made. This arrangement is best described as:
   1. A purchase money mortgage.
   2. A deed of trust.
   3. An installment land contract.
   4. A sale-leaseback.

Introduction

When real property is used as collateral to secure repayment of a debt, a security interest in the property is created. This interest gives the creditor (lender) the right to take action against the property if the debtor (borrower) defaults on the primary obligation (typically a promissory note). Various legal devices can be used to create such security interests. The most common device is the mortgage, but other arrangements can function similarly and may be treated as equitable mortgages by the courts. Understanding the different types of security devices is essential for analyzing property transactions and foreclosure issues on the MBE.

Key Term: Security Interest
An interest in property created to ensure the payment of a debt or the performance of an obligation.

In all of these transactions, it is critical to distinguish between:

• The primary obligation (usually a written promise to pay money, called a promissory note), and
• The security device (the mortgage, deed of trust, or similar instrument that makes the real property available to satisfy the debt).

Key Term: Promissory Note
A written promise by the borrower to repay a specified sum, usually with interest, according to stated terms; it represents the personal obligation to pay.

The note and the security device are conceptually separate. A lender can hold a valid note but an invalid mortgage (or vice versa), and on the MBE some questions turn on whether the creditor has both.

Types of Security Devices

Mortgage

A mortgage is a security interest in real property held by a lender as security for a debt, usually a loan of money. The borrower is the mortgagor, and the lender is the mortgagee. The mortgage instrument itself typically must be in writing to satisfy the Statute of Frauds, and it is usually recorded to protect the mortgagee against later interests.

Key Term: Mortgage
A security interest in specific real property to secure payment of a debt.

Key Term: Mortgagor
The debtor/borrower who gives the mortgage.

Key Term: Mortgagee
The creditor/lender who receives the mortgage interest.

The mortgagor’s personal promise to repay is normally contained in the separate promissory note. If the mortgagor defaults, the mortgagee’s primary remedy against the land is foreclosure; the note also allows the lender to seek a personal money judgment (a deficiency judgment) if the foreclosure sale does not satisfy the debt.

Theories of the Mortgagee’s Interest

Two primary legal theories exist regarding the nature of the interest held by the mortgagee:

Key Term: Lien Theory
The view that a mortgage creates only a security lien; legal and equitable title remain with the mortgagor until foreclosure.

Key Term: Title Theory
The view that a mortgage transfers legal title to the mortgagee until the debt is paid, with the mortgagor retaining only equitable title.

Key Term: Intermediate Theory
A hybrid approach under which the mortgagor keeps legal title until default; upon default, legal title automatically shifts to the mortgagee.

1. Lien Theory (Majority View):

   • The mortgagee holds only a security lien on the property.
   • The mortgagor retains legal and equitable title and the right to possession unless and until foreclosure occurs.
   • The mortgagee generally cannot take possession before foreclosure is complete, absent a specific agreement (such as an assignment of rents after default).
   • Because the mortgage is viewed merely as a lien, granting a mortgage does not sever a joint tenancy in most lien theory states.

2. Title Theory (Minority View):

   • Under traditional common law, the mortgage conveyed legal title to the mortgagee.
   • The mortgagee retained legal title until the mortgage was satisfied or foreclosed.
   • Subject to the terms of the mortgage, the mortgagee could in theory take possession at any time.
   • Granting a mortgage by only one joint tenant is treated as a transfer of that tenant’s title and does sever a joint tenancy in many title theory jurisdictions.

3. Intermediate Theory (Minority View):

   • Legal title remains with the mortgagor until default.
   • Upon default, legal title automatically passes to the mortgagee (often without the need for a separate conveyance), allowing faster foreclosure.
   • This approach preserves the mortgagor’s full rights pre‑default but moves closer to title theory after default.

MBE questions often assume lien theory unless the question states otherwise, but they may test whether a mortgage severs a joint tenancy. Look closely for language indicating that the jurisdiction follows title theory.

Purchase Money Mortgage (PMM)

A PMM is a specific type of mortgage used to finance the acquisition of the property itself. It can be given either to the seller of the property as part of the purchase price, or to a third‑party lender (like a bank) whose loan enabled the buyer to acquire the property.

Key Term: Purchase Money Mortgage
A mortgage given to secure a loan that is used to acquire the mortgaged real property.

Key characteristics:

• Timing: The loan proceeds are used to buy the property, and the mortgage is given at the same time (or as part of the same transaction).
• Parties:
  • Seller‑financed PMM: The seller conveys title to the buyer and takes back a mortgage to secure the unpaid portion of the purchase price.
  • Third‑party PMM: A bank or other lender advances funds that the buyer uses to pay the seller; the lender receives a mortgage on the property.

On the MBE, PMMs are important because of their typical priority rules:

• A properly recorded PMM usually has priority over most other liens or mortgages that arise after the buyer acquires title.
• A PMM can even have priority over certain earlier interests that attached to the land before the buyer acquired it, because the PMM enabled the buyer to obtain title at all.
• Between a seller‑financed PMM and a third‑party PMM, many jurisdictions give the seller’s PMM priority if both are recorded. (If the exam question cares about this distinction, it will usually tell you.)

Deed of Trust

Functionally similar to a mortgage, a deed of trust involves three parties: the debtor/borrower (trustor), a third-party trustee (often associated with the lender), and the lender (beneficiary). The trustor conveys title to the trustee, who holds it for the benefit of the beneficiary (lender). If the trustor defaults, the beneficiary instructs the trustee to foreclose.

Key Term: Deed of Trust
A security device where the borrower (trustor) gives a deed to a trustee who holds title for the benefit of the lender (beneficiary).

Key Term: Trustor
The borrower who conveys title to a trustee under a deed of trust.

Key Term: Trustee
The neutral third party who holds legal title under a deed of trust for the benefit of the lender.

Key Term: Beneficiary
The lender for whose benefit the trustee holds title under a deed of trust.

Many states permit non‑judicial foreclosure under a power of sale clause commonly found in deeds of trust.

Key Term: Power of Sale
A clause in a mortgage or deed of trust authorizing the holder to sell the property, usually through a non‑judicial process, upon the borrower’s default.

Key features of deeds of trust:

• The trustee holds bare legal title; the trustor retains equitable ownership and possession unless there is a default.
• On default, the beneficiary may direct the trustee to sell the property under the power of sale, often without filing a lawsuit. This is typically faster and less expensive than judicial foreclosure required in some mortgage states.
• For most MBE purposes, a deed of trust is treated the same as a mortgage: rules on priority, redemption, and deficiency judgments apply to both, unless the question is specifically testing non‑judicial foreclosure.

Installment Land Contract

Also known as a contract for deed, this is an agreement where the buyer (vendee) agrees to make regular installment payments to the seller (vendor) over a period of time. The vendor retains legal title until the final payment is made, at which point the vendor delivers the deed.

Key Term: Installment Land Contract
A contract where the buyer makes installment payments to the seller, and the seller retains legal title until the full price is paid.

Key Term: Vendor
The seller under an installment land contract, who retains legal title until the buyer completes payment.

Key Term: Vendee
The buyer under an installment land contract, who holds an equitable interest while paying the price over time.

Traditional rules and modern trends:

• Traditional view:

  • The vendor retained legal title and strong control.
  • If the buyer defaulted, the vendor could cancel the contract, retake possession, and keep all payments made as liquidated damages.
  • Forfeiture clauses (stating that all previous payments were forfeited upon default) were routinely enforced.

• Modern trend:

  • Courts view installment land contracts as functionally similar to mortgages.
  • Many jurisdictions require foreclosure procedures rather than allowing simple forfeiture, especially when the buyer has made substantial payments or improvements.
  • Courts may provide:
    • A grace period to cure default (similar to an equity of redemption).
    • Restitution to the buyer for payments exceeding the seller’s actual damages.
    • Specific performance or reformation in unusual cases.

This modern approach reflects the fact that the vendee has an equitable ownership interest from the outset; the seller’s retention of title is treated as a security device rather than a true right to terminate without process.

Equitable Mortgages

Courts will sometimes treat a transaction as a mortgage, despite its form, if it was intended as security for an obligation. This is an equitable mortgage. The basic idea is that substance controls over form: if the parties actually meant to create security for a debt, equity will not allow the creditor to bypass foreclosure protections by dressing the deal up as a sale or lease.

Key Term: Equitable Mortgage
A transaction that, despite its form (e.g., an absolute deed), a court determines was intended as security for an obligation and treats as a mortgage.

Common examples include:

1. Absolute Deed Intended as Security

If a landowner borrows money and gives the lender a deed to the land that appears absolute on its face, courts may treat this as an equitable mortgage if clear and convincing evidence shows it was intended merely as security.

Key Term: Absolute Deed
A deed that, on its face, conveys full title with no mention of any security interest or right of reconveyance.

Relevant factors (no single factor is decisive):

• Existence of a continuing debt (rather than a completed sale price).
• The grantee’s promise to reconvey the property upon repayment.
• Gross inadequacy of the stated price compared to the property’s true value.
• The grantor’s financial distress at the time of conveyance.
• Prior negotiations for a loan rather than a sale.
• The grantor’s continued possession and payment of taxes or insurance after the deed.

Parol evidence is admissible to show that the deed was intended as security, even though the deed is absolute on its face.

If the court finds an equitable mortgage:

• The grantor is treated as the mortgagor and retains an equity of redemption.

Key Term: Equity of Redemption
The mortgagor’s right, up to the time of foreclosure sale, to pay the debt and reclaim unencumbered title.

• The grantee is treated as a mortgagee and must foreclose (judicially or under a power of sale) to cut off the grantor’s interest.
• Any attempted “self‑help” retention by the grantee as full owner, without foreclosure, will not be honored.

2. Sale‑Leaseback as Security

A landowner sells property for cash and then leases it back from the buyer for a long term. Sometimes the deal includes an option for the original owner to repurchase at a fixed price. This may in substance be a secured loan: the “buyer” is really a lender receiving payments disguised as rent.

Key Term: Sale‑Leaseback
A transaction in which an owner sells property and simultaneously leases it back, which may be treated as a disguised security agreement if intended to secure a loan.

Courts will consider:

• Whether the rental payments are roughly equivalent to what mortgage payments would be.
• Whether the original owner has a repurchase option, especially at a price significantly below expected future value.
• Whether the buyer demanded the arrangement as a way to protect a loan rather than insisting on a true sale.
• Whether the original owner remains in uninterrupted possession and bears incidents of ownership (taxes, insurance).

If the arrangement is deemed security, the court will treat it as an equitable mortgage, giving the original owner rights similar to those of a mortgagor, including the equity of redemption and protection against forfeiture without foreclosure.

3. Installment Contracts and Other Devices

As discussed above, installment land contracts may also be treated as equitable mortgages, particularly when:

• The buyer has paid a substantial portion of the purchase price, or
• The buyer has made significant improvements to the property.

Modern courts may similarly recharacterize other unusual financing devices if they function as security for a debt.

Worked Example 1.1

Debtor, facing financial hardship, approached Creditor for a loan. Debtor owned Blackacre, worth $200,000. Creditor loaned Debtor$50,000. Debtor signed a document stating, "I hereby convey Blackacre to Creditor." Simultaneously, they orally agreed that if Debtor repaid the $50,000 plus 10% interest within one year, Creditor would reconvey Blackacre to Debtor. Debtor failed to repay within the year. Creditor claims absolute ownership of Blackacre. Debtor argues the transaction was merely security. How should a court likely rule?

Answer:
The court will likely rule that the transaction created an equitable mortgage. Despite the form of an absolute deed, the circumstances strongly suggest a security arrangement: the "purchase price" ($50,000) was significantly less than the property's value ($200,000), Debtor was in financial distress, and there was an oral agreement for reconveyance upon repayment. Courts look beyond the form to the substance and intent of the parties. Parol evidence of the oral agreement is admissible to show the deed was intended as security. Creditor must foreclose to cut off Debtor’s equity of redemption.

Worked Example 1.2

Developer sells lots in a new subdivision. Buyer purchases Lot 1 using an installment land contract, paying $10,000 down and agreeing to pay$1,000 per month for 10 years, after which Developer will deliver the deed. After 5 years of payments ($70,000 total paid), Buyer misses a payment. The contract contains a forfeiture clause. What are Developer's traditional rights, and how might modern law differ?

Answer:
Traditionally, Developer could declare forfeiture, cancel the contract, retain all payments made ($70,000), and retake possession of Lot 1 because legal title never passed to Buyer and the contract expressly allowed forfeiture. Modern courts, however, often view such forfeiture as harsh, especially where the buyer has built substantial equity. They might treat the contract as an equitable mortgage, requiring Developer to initiate foreclosure proceedings, or they might provide a grace period for Buyer to cure the default (functionally an equity of redemption), or allow Buyer restitution of payments exceeding Developer’s actual damages.

Worked Example 1.3

Owner sells Blackacre to Buyer for $300,000. Buyer pays$50,000 down, borrows $200,000 from Bank (giving Bank a mortgage on Blackacre), and gives Owner a note and mortgage for the remaining$50,000. All documents are executed at the same closing. Which of the following security interests is (are) purchase money mortgages?

• Bank’s $200,000 mortgage
• Owner’s $50,000 mortgage

Answer:
Both Bank’s mortgage and Owner’s mortgage are purchase money mortgages. A PMM is any mortgage given to secure a loan that is used to finance the acquisition of the property. Bank’s funds went directly to the purchase price, and Owner is financing part of the price. On the MBE, both seller‑financed and third‑party acquisition loans given at the time of purchase are PMMs and often receive special priority.

Worked Example 1.4

Borrower lives in a title theory jurisdiction. Borrower and Co‑Owner hold Blackacre as joint tenants with right of survivorship. Borrower alone takes out a mortgage to secure a personal loan from Bank. Borrower later dies. Co‑Owner claims sole ownership by right of survivorship; Bank claims Borrower’s interest survives to satisfy the mortgage. Who prevails?

Answer:
In a title theory jurisdiction, the mortgage is treated as a transfer of Borrower’s legal title to Bank. That transfer severs the joint tenancy as to Borrower’s share, converting it to a tenancy in common. When Borrower dies, Co‑Owner keeps her undivided half as tenant in common, and Borrower’s half interest (now subject to Bank’s mortgage) passes through Borrower’s estate. Bank can foreclose against that interest. Co‑Owner therefore does not take full title by survivorship. In a lien theory state, by contrast, the mortgage would normally not sever the joint tenancy, and Co‑Owner would prevail.

Comparative Overview: How the Devices Differ

It is useful to compare these devices along a few key dimensions that often matter on the MBE:

• Who holds legal title?

  • Mortgage (lien theory): Mortgagor.
  • Mortgage (title theory): Mortgagee (at least in form).
  • Deed of trust: Trustee.
  • Installment land contract: Vendor until final payment.
  • Equitable mortgage: Court re‑labels legal title to reflect the intended security arrangement.

• Who holds possession before default?

  • Almost always the borrower/user (mortgagor, trustor, vendee), unless the parties expressly agree otherwise or default occurs in a title/intermediate theory jurisdiction.

• How is the borrower’s interest cut off?

  • Mortgages and deeds of trust: Foreclosure (judicial or non‑judicial under power of sale).
  • Installment land contracts: Traditionally forfeiture; modern law frequently requires foreclosure or similar procedures.
  • Equitable mortgage: Treated like a mortgage—foreclosure required; borrower has equity of redemption.

Being able to re‑characterize a transaction—recognizing when an installment contract or absolute deed is really a mortgage—is a frequent MBE testing angle.

Key Point Checklist

This article has covered the following key knowledge points:

• Security interests are used to secure debt with real property and are separate from the associated promissory note.
• The most common device is a mortgage (Mortgagor = Borrower, Mortgagee = Lender), which must be in writing and is usually recorded.
• Lien theory (majority) treats the mortgage as a lien only; title and possession stay with the mortgagor. Title theory (minority) treats the mortgage as a transfer of legal title to the mortgagee; intermediate theory shifts title to the mortgagee upon default.
• A Purchase Money Mortgage (PMM) finances the property purchase itself; both seller‑financed and third‑party acquisition loans can be PMMs, and PMMs often enjoy special priority over other liens.
• A Deed of Trust involves a borrower (Trustor), lender (Beneficiary), and a Trustee holding title; many states allow non‑judicial foreclosure under a power of sale.
• An Installment Land Contract involves the seller (Vendor) retaining legal title until the buyer (Vendee) completes payments; traditional forfeiture clauses are often limited by modern law, which may treat the contract as an equitable mortgage.
• Courts may find an Equitable Mortgage where a transaction (like an absolute deed or sale‑leaseback) was intended as security; substance prevails over form, and the borrower retains an equity of redemption.
• Sale‑leaseback arrangements and other creative financing devices can be recharacterized as mortgages when they function to secure a loan.
• Proper classification of the security device is important on the MBE for determining title, possession, foreclosure procedure, redemption rights, and lien priority.

Key Terms and Concepts

• Security Interest
• Promissory Note
• Mortgage
• Mortgagor
• Mortgagee
• Lien Theory
• Title Theory
• Intermediate Theory
• Purchase Money Mortgage
• Deed of Trust
• Trustor
• Trustee
• Beneficiary
• Installment Land Contract
• Vendor
• Vendee
• Equitable Mortgage
• Absolute Deed
• Sale‑Leaseback
• Equity of Redemption
• Power of Sale