A MORTGAGE PRIMER

Professor Cyril A. Fox
University of Pittsburgh School of Law

The following materials are designed to expand on our summary treatment of mortgage law. Any attempt to describe in detail the varying jurisdictions' treatments of the mortgage relationship in a "primer" is doomed to failure. Failure is not the objective. If you are interested in exploring some 0of these ideas further, I have provided citations to two leading works: Grant S. Nelson & Dale A. Whitman, REAL ESTATE FINANCE LAW (4th ed. 2001) (cited as REFL § __) and 4 THE AMERICAN LAW OF PROPERTY (Casner ed. 1952) (cited as 4 A.L.P. § __).

Any basic analysis of mortgage transactions should begin with the two instruments involved, the note (or bond if under seal) and the mortgage. The note creates an obligation (debt) of the borrower, or mortgagor, to pay to the lender, or mortgagee, a specific sum of money, usually to be repaid with interest in a specified manner and by a specified time. Usually, the borrower is personally obligated to pay the debt in accordance with the terms of the note. The lender can recover a judgment against the borrower if the borrower defaults (fails to pay the debt in accordance with the terms of the note) and can execute on that judgment against any assets of the borrower. The lender is not limited to the land covered by the mortgage when it seeks to satisfy the debt created by the note.

The mortgage is in the form of a conveyance to the lender of an interest in specific real estate. There is a condition attached to the lender's interest that, if the note is repaid in accordance with its terms, the lender's interest in the real estate will end. The mortgage gives the lender a security interest in the real estate. If properly recorded under state law, the lender has an interest in the real estate at least superior to the borrower's general (unsecured) creditors, as well as to the borrower's secured creditors whose claims arise after the mortgage was recorded.

Both note and mortgage create obligations of the borrower. The note usually requires the payment of money only. The mortgage creates a number of obligations to the lender not directly related to the payment of money. These are intended to preserve the value of the real estate as security for payment of the debt. They may include a duty to pay taxes and assessments on the real estate, to keep improvements in repair, to maintain both property damage and personal liability insurance for benefit of lender, and, of course, to pay the debt in accordance with the terms of the note.

Because the two instruments create different duties, the borrower may be paying the debt promptly and, yet, be in default under the mortgage (e.g., by allowing an insurance policy to lapse). A default in an obligation under the mortgage usually permits the lender to declare the entire unpaid amount of the note presently due (to accelerate the borrower's obligation to pay the balance due). If the borrower does not pay, the lender may proceed against Blackacre under the terms of the mortgage. However, if the mortgage does not provide that a particular event of default permits acceleration of the duty to pay the balance due, the lender can not sue for more than on the note.

Different jurisdictions regard the interest of the borrower in the real estate differently. There are three general views, called "lien," "title" or "intermediate" jurisdictions. In a lien jurisdiction, the mortgage creates only a lien on the real estate which will allow the lender to reach the property to satisfy its claim. In a title jurisdiction, the mortgage title to the lender. This title becomes void if the borrower satisfies the obligtion for whose performance the mortgage was made. If the obligation is not satisfied, or the borrower is otherwise in default under the mortgage, the lender is entitled to immediate possession of the real esate. Intermediate jurisdictions partake of parts of both "lien" and "title" jurisdiction theories.

Only in a "title" jurisdiction does the lender have any even a theoretical right to possession of the real estate before default. In an "intermediate" jurisdiction, the lender may be entitled, as against the borrower to take possession, but only upon default under the mortgage. (Remember, a default under the note usually is automatically a default under the mortgage.) In most "lien" theory jurisdictions, the lender is not entitled to possession even after default under the mortgage but must proceed by foreclosure or by an action on the note. See REFL §§ 1.5, 4.1 to 4.3; 4 A.L.P. §§ 16.13 to 16.16. If the borrower defaults on its obligations under the note in any of these three jurisdictions , the lender can ask a court to sell the real estate tosatisfy the debt due on the note.

Even after default, a court of equity will usually allow allow the borrower to cure the default or to redeem its estate in the land by paying the lender the balance due or by taking appropriate steps to cure the default (e.g., obtaining a new insurance policy). The debtor' power to cure a default without the lender's permission, or even against the lender's wishes, is enforceable in equity and is called the borrower's equity of redemption. To cut off that equitable power, the device of foreclosure was developed. Although a particular jurisdiction may afford more than one method of foreclosing this equitable power,1 all states have a mechanism of foreclosure by judicial sale. REFL § 7.11; 4 A.L.P. § 16.185. For purposes of this discussion, we will assume that all foreclosures are by judicial sale.

Satisfaction of Borrower's Obligation -- Foreclosure, Surplus Funds, and Deficiency Judgments

Assume that Bill Borrower owns Blackacre in fee simple absolute, free of all liens. Blackacre has a present market value of $60,000. Bill needs money to pay for a jade buddha statue which he has bought for $40,000. He borrows this money from Louise Lender, securing his note for the $40,000 with a mortgage on Blackacre. The note requires Bill to repay the $40,000, plus a 10% interest per year, in five years. Bill no longer "owns" Blackacre as he did before the mortgage. Instead he has a power to regain full ownership by paying Louise the $40,000 plus interest. That power is Bill's equity of redemption in Blackacre. Its value at any time is the difference between the market value of Blackacre at that time and the amount yet to be paid on the note. For example:

Market Value of Blackacre $60,000 $70,000 $30,000
less Amount of Unpaid Mortgage Note   40,000   30,000   20,000
=   Value of Equity of Redemption $20,000 $30,000 $10,000

In all three situations, someone would be willing to pay Bill the value of his equity of redemption for an assignment (conveyance) of his power to regain title to Blackacre free of Louise's claim.

Suppose that Bill is unable to repay the note when it comes due. Louise now has two choices. She may sue on the note, recover a judgment against Bill and levy on (have sold) any of Bill's assets, including Blackacre and the jade buddha, to raise money to satisfy the judgment. If she levies on the jade buddha only and recovers $40,000 plus any unpaid interest, she can be required to "satisfy" the mortgage, ending her security interest in Blackacre. Alternatively, Louise may proceed against only Blackacre under the mortgage with an action of mortgage foreclosure. (Technically, what will be "foreclosed" is Bill's power to exercise his equity of redemption, not the mortgage).

Louise chooses to proceed by way of foreclosure under the mortgage. Uncharacteristically at the foreclosure sale, Blackacre sells for $60,000 plus unpaid real estate taxes and the costs of sale. Louise's debt is $40,000. Bill will receive the $20,000 surplus.

If Blackacre sells for only $30,000 plus costs, and the debt is $40,000, Bill still owes Louise $10,000 on the note. Without a controlling statute, Louise can now proceed against Bill's other assets, including the jade buddha, for the $10,000 deficiency.

Because the lender may be the only bidder at the foreclosure sale, lenders often bid only a nominal sum over the costs of sale, obtaining the mortgage debtor's title to the land and a deficiency judgment for the balance due on the note. For example, Louise might bid $1.00 plus unpaid real estate taxes and the costs of the sale. If no one else bids for Blackacre, Louise will obtain Bill's full title to the land. Louise credits Bill with the amount "received" from the sale ($1.00) against the amount of his debt ($40,000.00). This leaves an unpaid balance or deficiency due Louise of $399,999.00.

This obviously unjust state of affairs resulted, in many states adopting anti-deficiency legislation. Pennsylvania's Deficiency Judgment Act of 1941, substantially renacted at 42 Pa.C.S.A. §§ 8103 to 8104. Under the Act, any judgment creditor, including a lender who as obtained a judgment in mortgage foreclosure, who purchases real estate, directly or indirectly, at the execution sale can not obtain a deficiency judgment against the debtor unless the creditor first petitions the court to fix the fair market value of that real estate at the time of the judicial sale. Any deficiency judgment will be limited to the difference between the amount of the original judgment and the fair market value of the real estate (less costs of sale and encumbrances not discharged by the sale) instead of the amount "paid" at the sale. Failure to petition within six months of the judicial sale permits the judgment debtor to compel satisfaction of record of the judgment by the judgment creditor. Moreover, the judgment creditor's failure to satisfy the judgment within 30 days after request to do so can result in monetary liability for the creditor. See 42 Pa. C.S.A. § 8104(b); Fidelity Federal Sav. and L. Ass'n v. Capponi, 684 A.2d 580, (Pa. Super. 1996), reargument denied, appeal denied, 698 A.2d 67 (Pa. 1997). See also REFL §§ 8.1 to 8.3; 4 A.L.P. §§ 16.199 to 16.203.

Transfers of the Equity of Redemption

While still able to exercise his equity of redemption and regain full ownership of Blackacre unencumbered by Louise's mortgage, Bill can transfer all or part of his interest in Blackacre (his equity of redemption) to a third party by sale, gift, or further mortgage. The nature of the transfer will not alter Louise's ability to recover a personal judgment against Bill. Nor will it affect her ability to have Blackacre sold at a foreclosure sale in the event of a default under the mortgage. It will determine her ability to recover a personal judgment against Bill's transferee, however.

(a)  "Subject to" Transfers. If Bill transfers his equity of redemption to Tracy and Tom Transferee under a deed which recites that the Transferees are taking Bill's interest in Blackacre subject to Louise Lender's mortgage, the Transferees will owe no personal duty to Louise to pay the note. That is, Louise will not be able to obtain a personal judgment against Tracy and Tom and have any of their personal assets sold to satisfy the judgment. If the debt is not paid, or the mortgage otherwise becomes in default, Louise can proceed to foreclose on the mortgage and have Blackacre sold to satisfy the debt. Since the Transferees have only Bill's equity of redemption, foreclosure of that equity will terminate their interest in Blackacre (assuming they have been made parties to the foreclosure action). If the fair market value at the time of the foreclosure sale is $30,000, and the amount of the debt is $40,000, Louise may proceed against Bill's jade buddha for the deficiency, but not against any personal assets of the Transferees.

Where the Transferees take "subject to" the mortgage, they normally pay Bill only the value of his equity of redemption at the time of purchase. The mortgage debt is expected to be paid from the future rents, issues, and profits of Blackacre.

Except in Pennsylvania (discussed below), American courts regard a transfer of the equity of redemption subject to the mortgage as one which creates no personal liability in the transferee to satisfy the note or mortgage. Of course, the Transferees are privileged to pay off the note and perfect their title to Blackacre by doing so. The potential loss of the land through foreclosure is usually sufficient incentive to induce them to do so. An additional incentive arises from Bill's ability to foreclose against the land if Louise chooses to enforce his personal liability on the note rather than to proceed by foreclosure. Upon satisfying the note, Bill becomes subrogated to Louise's rights under the mortgage and may proceed to foreclose the Transferee's equity of redemption by judicial sale of Blackacre. The Transferees have no liability to Bill, but Blackacre does "owe" Bill the amount he paid to Louise. See REFL §§ 5.1, 5.3, 5.9; 4 A.L.P. § 16.127, 16.130; McDowell Nat'l. Bank of Sharon v. Stupka, 310 Pa. Super. 141, 456 A.2d 540 (1983).

Although the doctrine of subrogation is not a simple one, the following description of its basis is found in 1 A.L.P. § 2.22:

Subrogation is a doctrine of equity applied in favor of any person who pays the debt or obligation of another [Blackacre] which is not his personal obligation, not as a volunteer interfering without adequate cause, but to protect an interest of his own [the debt created by the note] or of some other person on request, or in the performance of a secondary obligation as surety. It is a matter of justice and equity that he [Bill] should be placed in the position of the creditor [Louise] to whom he makes payment in order that he may enforce any security [lien on Blackacre] or other rights which the creditor has in connection with such debt.

(b)   "Assumption" Transfers. If the Transferees promise Bill that they will pay the mortgage debt owed to Louise as part of their obligations under the transfer of the equity of redemption, they are said to have assumed the mortgage. (The language of a deed is usually "hereby assumes and agrees to pay.") Although their promise normally is made to Bill in his deed to them, Louise can seek to compel their performance as a third party beneficiary of this promise or under some other theory. Now they do have a personal obligation to pay the mortgage, which Louise can enforce by foreclosure of the mortgage or by a suit against the Transferees. Louise can reach the Transferees' personal assets as well as Blackacre. Alternatively, she can sue Bill directly on the note and proceed against his jade buddha instead of Blackacre. In other words, after an assumption, Louise has three sets of assets from which to seek repayment of Bill's note: (1) Blackacre, (2) Bill's jade buddha and other assets, and (3) the Transferees' other assets.

Again, the Transferees normally will only pay Bill the value of his equity of redemption at the time of transfer. The purchase price of Bill's interest may be stated as the full market value of Blackacre without the mortgage. The Transferees are given a credit against that price by the amount of the mortgage debt which they are assuming. Now the mortgage debt may have to be paid from Tracy and Tom's personal assets.

If the Transferees default on the note or mortgage, Louise can foreclose on the mortgage and seek a deficiency judgment against Bill or the Transferees. To the extent that Bill is required to satisfy that judgment, or any other obligation on the note or mortgage assumed by the Transferees, he has an action against them, not by way of subrogation, but directly on their contract of assumption with him. See REFL §§ 5.1, 5.2, 5.4 to 5.8, 5.10 to 5.15; 4 A.L.P. §§ 16.128, 16.131 - 16.135.

Because of their promise in the deed from Bill (the assumption), Tracy and Tom owe Bill a duty to pay the debt when it becomes due even if they are no longer the owners of Blackacre at that time. In short, the mortgage debt has become a personal obligation of theirs just as if they had signed the original note. Steinert v. Galasso, 363 Pa. 393, 69 A.2d 841 (1949).

(c)   "Full Value" Transfers. It may be that the Transferees, in order to acquire Blackacre, have to pay Bill the full market value of Blackacre rather than just the value of his equity of redemption. In return, Bill promises to pay off the note as it becomes due.

Here, Louise still has the right, vis-a-vis Bill or the Transferees, to proceed against Blackacre by way of foreclosure should Bill fail to pay the note, or should the Transferees otherwise allow the mortgage to become in default. (She also may go against Bill's jade buddha, but not against personal assets of the Transferees.) Should Blackacre be taken from the Transferees by foreclosure of the mortgage, they will be able to recover its value from Bill for breach of his promise to them.

(d)  The Pennsylvania Position. In Pennsylvania, unless the transfer from Bill to Tracy and Tom is very carefully drafted, it matters little whether Tracy and Tom take "subject to" the mortgage or "assume and agree to pay" the mortgage. If they receive credit from Bill toward the purchase price for the amount of the unpaid mortgage, they are presumed to have "assumed" the mortgage and are bound to indemnify Bill for any losses suffered by him as a result of default on the mortgage or note. The only difference between the Transferees' obligation, in taking subject to the mortgage or expressly assuming its obligations, is in the ability of Louise to reach other assets of Tracy and Tom. In the former case, their personal liability runs only to Bill; in the latter, it runs to Louise as well as to Bill.

For an excellent, brief discussion of transfers of the equity of redemption which emphasizes Pennsylvania law, see Goldberg, "What to Do About Mortgages in the Sale of Real Property," 17 Prac. Lawyer #7 at 13 (1971); also see REFL §§ 5.8; 4 A.L.P. § 16.129; and see 21 P.S. §§ 655 and 656. For a case expanding upon the distinction between personal liability on the note and the liability of the land under the mortgage, see Bank of Pennsylvania v. G/N Enterprises, Inc., 316 Pa. Super. 367, 463 A.2d 4 (1983).

Another Type of Transaction -- "Junior Mortgages"

If Bill wants to build a display case for his jade buddha, remodel his kitchen, install aluminum siding on the garage, or take a trip to Bimini, he could borrow the money for these expenditures from Tracy and Tom, pledging his equity of redemption from Louise' mortgage as security for repayment of their loan to him. This agreement creates a junior mortgage or "second mortgage" on Blackacre. It provides Bill with a means of withdrawing value from his real estate without having to sell it outright. The "second" mortgage is considered a junior lien against Blackacre because Louise's mortgage (the "first" mortgage) has priority pf repayment "by" Blackacre.

In this transaction, Tom and Tracy' second mortgage will appear identical to Louise's mortgage, giving Tom and Tracy the same rights to seek satisfaction of their loan from the sale of Blackacre or from Bill's other assets. In one respect, however, it is quite different from Louise's mortgage. If Tom and Tracy must foreclose on their mortgage, the purchaser at the judicial sale will acquire only Bill's equity of redemption from Louise's mortgage. The sale will not affect Louise's rights or powers under either her mortgage or note (unless her mortgage provides that a default in any second mortgage operates as a default in her mortgage as well and she subsequently institutes an action to foreclose on that mortgage). The purchaser at Tom and Tracy' foreclosure sale will take Bill's equity of redemption "subject to" Louise's mortgage. In this situation, the purchaser normally will pay no more than the market value of Bill's equity of redemption. Louise's mortgage is not affected by the sale because it was prior in time to Tom and Tracy' mortgage. Absent statutory provisions altering the effect of judicial sales, a judicial sale passes only the interest of the party who institutes the sale.

Concluding Caveat

In the discussion of the rights and obligations of transferees of the equity of redemption, we have indicated that either Bill or Tom and Tracy may acquire some personal liability to the other party if the mortgage obligations are not satisfied in accordance with their terms. Subsequent changes in the obligations agreed to by Louise and only one of the parties may serve to discharge the liability of the other. For example, if Louise grants Bill an extension of time within which to pay the note, after Tom and Tracy have taken subject to the mortgage, the liability of Blackacre for the debt may be discharged. See 4 A.L.P. § 16.141; MGIC Financial Corp. v. H.A. Briggs Co., 24 Wash. App. 1, 600 P.2d 573 (1979) (discharge of mortgagor's personal liability on debt prevents foreclosure of the mortgage against the land). This effect is part of the law of suretyship, subrogation and indemnification. It is a very technical area. If you are interested in more information on these matters as applied to mortgages, read REFL §§ 5.17 to 5.19; 10.1 to 10.8; 4 A.L.P. §§ 16.145 to 16.153.
Top of This Page
© 2002 / Professor Cyril A. Fox / University of Pittsburgh School of Law