Mortgage law: an overview

There are many articles posted about optional financial instruments for creative finance, no money down transactions, and other considerations. You, as a potential buyer/seller, must be aware of the legality of a real estate transaction and how it affects the sale or acquisition of real property. Below is a quick overview of the mortgage law:

A mortgage involves the transfer of an interest in land as security for a loan or other obligation. It is the most common method of financing real estate transactions. The mortgagor is the party transferring the interest in land. The mortgagee, usually a financial institution, is the provider of the loan or other interest given in exchange for the security interest. Normally, a mortgage is paid in installments that include both interest and a payment on the principle amount that was borrowed. Failure to make payments results in the foreclosure of the mortgage. Foreclosure allows the mortgagee to declare that the entire mortgage debt is due and must be paid immediately. This is accomplished through an acceleration clause in the mortgage. Failure to pay the mortgage debt once foreclosure of the land occurs leads to seizure of the security interest and it's sale to pay for any remaining mortgage debt. The foreclosure process depends on state law and the terms of the mortgage. The most common processes are court proceedings (judicial foreclosure) or grants of power to the mortgagee to sell the property (power of sale foreclosure). Many states regulate acceleration clauses and allow late payments to avoid foreclosure.

Three theories exist regarding who has legal title to a mortgaged property. Under the title theory title to the security interest rests with the mortgagee. Most states, however, follow the lien theory under which the legal title remains with the mortgagor unless there is foreclosure. Finally, the intermediate theory applies the lien theory until there is a default on the mortgage whereupon the title theory applies.

The mortgagor and the mortgagee generally have the right to transfer their interest in the mortgage. Some states hold that even when the purchaser of a property subject to a mortgage does not explicitly take over the mortgage the transfer is assumed. Mortgagees employ due-on-sale and due-on-encumbrance clauses to prevent the transfer of mortgages. These clauses allow acceleration (having the principal and interest become due immediately) of the mortgage. In 1982, Congress made these clauses enforceable nationwide by passage of the Garn-St Germain Depository Institutions Act of 1982. The law of contracts and property govern the transfer of the mortgagee's interest.

If the mortgage being foreclosed is not the only lien on the property then state law determines the priority of the property interests. For example, Article 9 of the Uniform Commercial Code governs conflicts between mortgages on real property and liens on fixtures (personal property attached to a piece of real estate).

When a mortgage is a negotiable instrument Article 3 of the Uniform Commercial Code governs it. The mortgagee may use a mortgage as a security interest.

The law of mortgages is mainly governed by state statutory and common law. Federal or state law or agencies depending on under whose law they were chartered or established regulate mortgagees. The Federal Home Loan Bank Board regulates savings and loan associations chartered by the government. The Office of The Comptroller of the Currency charters national banks. The National Credit Union Administration regulates Credit Unions.

Federal agencies that purchase loans and mortgages are the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the Government National Mortgage Association. The federal government also insures mortgages through the Federal Housing Association and the Department of Veterans Affairs.

Secured transaction law: an overview

A security interest arises when in exchange for a loan a borrower agrees, in a security agreement, that the lender (the secured party) may take specified collateral owned by the borrower if he or she should default on the loan. A security interest also provides the secured party with the assurance that if the debtor should go bankrupt he or she may be able to recover the value of the loan by taking possession of the specified collateral instead of receiving only a portion of the borrowers property after it is divided among all creditors. Security agreements are contracts of the Uniform Commercial Code that govern security interests in personal property. It has been adopted, with some modifications, by every state. A security agreement must comply with other state laws governing contracts.

Article 9 of the Uniform Commercial Code covers most types of security agreements for personal property that are both consensual and commercial. This includes fixtures, personal property that is "fixed" to real property such as a water heater. Statutory liens (e.g. a mechanics lien) are generally not governed by Article 9 but by the individual statute that creates them. Article 9 contains a statute of frauds, which requires a security agreement to be in writing unless it is pledged. A pledged security agreement arises when the borrower transfers the collateral to the lender in exchanger for a loan (e.g., a pawnbroker). The "perfection" of a security agreement allows a secured party to gain priority to the collateral over any third party. To perfect a security agreement the filing of a public notice is usually required.

Article 9 also provides for the resolution of conflicts if there are multiple security interests or liens on specific collateral. Part 5 of Article 9 deals with the procedures to be followed when a borrower defaults.

Negotiable instruments law: an overview

State statutory law mainly governs negotiable instruments. Every state has adopted Article 3 of the Uniform Commercial Code (UCC), with some modifications, as the law governing negotiable instruments. The UCC defines a negotiable instrument as an unconditioned writing that promises or orders the payment of a fixed amount of money. Drafts and notes are the two categories of instruments. A draft is an instrument that orders a payment to be made. An example is a check. A note is an instrument that promises that a payment will be made. Certificates of deposit (CD's) are notes. Drafts and notes are commonly used in business transactions to finance the movement of goods and to secure and distribute loans. To be considered negotiable an instrument must meet the requirements stated in Article 3. Negotiable instruments do not include money, payment orders governed by article 4A (fund transfers) or to securities governed by Article 8 (investment securities).

The rule of derivative title, which is applicable in most areas of the law, does not allow a property owner to transfer rights in a piece of property greater than his own. If an instrument is negotiable this rule is suspended. A good faith purchaser, who does not have any knowledge of a defect in the title or claims against it, takes title to the instrument free of any defects or claims. In relation to the suspension of the rule of derivative title, Article 3 provides for warranties to protect the parties in transactions involving negotiable instruments.

Property signifies dominion or right of use, control, and disposition, which one may lawfully exercise over things, objects, or land. One of the basic dividing lines between properties is that between real property and personal property. Generally, the term real property refers to land. Land, in its general usage, includes not only the face of the earth but also everything of a permanent nature over or under it. This includes structures and minerals.

There are further divisions within the real property classification. The most important are freehold estates, non-freehold estates, and concurrent estates. (Others are future interests, specialty estates, and incorporeal interests). Freehold estates are those in which an individual has ownership for an indefinite period of time. An example of a freehold estate is the "fee simple absolute", which is inheritable and lasts as long as the individual and his heirs wants to keep it. Another example is the "life estate", in which the individual retains possession of the land for the duration of his or her life. Non-freehold estates are property interests of limited duration. They include tenancy for years, tenancy at will, and tenancy at sufferance. Concurrent estates exist when property is owned or possessed by two or more individuals simultaneously.

For the most part, states have exclusive jurisdiction over the land within their borders, and their law concerning the kind of interests that can be held and how they are created is not subject to federal law.