Transferring Mortgaged Property
The owner of mortgaged property can transfer her property just like any other owner. But she can’t change the rights of the mortgagee. Because a mortgage is an interest in land, it stays with the land even if the mortgagor transfers the property to someone else, just as a running covenant or appurtenant easement would stay with the land.
And, of course, that means the property isn’t worth as much as if there weren’t any mortgage encumbering the property.
Even though the right to transfer is a fundamental attribute of property ownership, mortgagees may have good reasons to be concerned about transfers of the mortgaged property. After the mortgagor transfers the property, the new owner is expected to make the payments on the mortgage loan, and the original mortgagor no longer has the same incentive to make sure the payments are made, because she doesn’t own the mortgaged property anymore.
The new owner may not be as creditworthy and reliable as the original mortgagor, and therefore a transfer may increase the risk of default. The new owner also may not take good care of the property, and the property therefore will decline in value, reducing the mortgagee’s security.
Mortgages therefore often include clauses restricting transfer, typically a due-on-sale clause that says the mortgagee may accelerate the debt and foreclose if the mortgagor transfers the property without the mortgagee’s prior written consent. Some states held that such clauses are invalid restraints on alienation.
However, a 1982 federal statute preempts state law and makes such due-on-sale clauses enforceable except in certain situations. In most cases, if a mortgagor wants to transfer mortgaged property without paying off the loan, she must first get the lender’s written consent because of a due-on-sale clause. Otherwise, the lender may exercise its right to demand immediate payment of the remaining debt.
Assuming mortgage debt
If the mortgagor transfers the mortgaged property and doesn’t pay off the mortgage loan in the process, the property is still subject to the mortgage, assuming it’s recorded or the new owner of the property otherwise has notice of the existing mortgage.
The original mortgagor no longer owns the property and so won’t keep making the mortgage payments. Instead, the new owner will have to make the mortgage payments, or else the mortgagee can foreclose and sell the property.
However, the new owner isn’t personally liable for the unpaid debt simply because she bought property that was subject to a mortgage. If there’s a default on the loan, the mortgagee can foreclose but can’t sue the new owner for a deficiency on the loan itself.
When she buys the property from the mortgagor, the buyer of the mortgaged property can expressly agree to be personally liable on the debt. Such an agreement is called assuming the loan. In that case, the mortgagee is a third-party beneficiary of the buyer’s promise to the mortgagor and can directly sue the new owner for breach of the obligation to pay the debt.
Enforcing a mortgage against the transferor
The mortgagor remains liable on her contract to repay the mortgage loan even if she transfers the property to another, and even if that buyer assumes the loan. Her agreement with her buyer can’t change the rights of the mortgagee, which has a contract with the mortgagor requiring her to pay the debt.
Even if the mortgagee consents to the transfer, the mortgagor remains liable for performance of the loan obligation. However, the mortgagee can expressly release the mortgagor from the debt, after which the mortgagor is no longer liable.
The mortgagor is also released from the debt if the mortgagee and the new owner modify the loan in some way that increases the risk of default and liability without the mortgagor’s consent.
For example, if the mortgagee and the new owner agree to extend the term for repayment or to increase the interest rate, such changes would increase the risk of liability on the debt and would release the mortgagor from the obligation if she hadn’t consented to such changes.
If the buyer assumes the mortgage but the mortgagor isn’t released and remains liable on the debt, the buyer is said to have the principal obligation and the mortgagor is a surety for the buyer’s performance. That means that the buyer is primarily liable and the mortgagor is secondarily liable.
In the event of default, the mortgagee can sue either or both of them. But if the mortgagor pays the debt, she can recover that payment from the assuming buyer who is primarily liable to repay the debt. If she pays off the debt, she steps into the shoes of the mortgagee and can even foreclose on the property to recover the amount she paid to the mortgagee.