By Dave Phillips
Security can be defined as “something that secures or makes safe; protection; defense.”
Typically, when a bank loans money, it will do two things. 1) It will execute a “note” with the borrower. The note is a contract between the bank and the borrower setting forth the terms of the loan. 2) It will require the borrower to grant a mortgage of the borrower’s land as security for the debt recited in the note.
A secured transaction is created when a person or entity receiving a loan grants property as collateral for repayment of the loan. The lender in the transaction is said to be secured, because if the loan is not paid in a timely fashion, the lender may foreclose and receive the property in satisfaction, or at least partial satisfaction, of the loan. In essence, it is a form of insurance for repayment.
The note is distinct from the mortgage. A loan can exist without a mortgage. In this instance, the lender’s remedy in case of default would be to sue for breach of contract, a claim in-personam. The mortgage gives the lender an additional and powerful remedy upon default, a claim in-rem.
Mortgage: A mortgage is a grant of land offered as collateral for an underlying loan.
Mortgagor: A person or entity that mortgages its land to the lender.
Mortgagee: A person or entity that receives a grant of mortgage from the land owner.
The following story demonstrates the creation and function of the real estate mortgage.
Mr. X has inherited land from his deceased father. The land has an appraised value of $200,000.00, free of liens. Mr. X has some ideas concerning future career objectives, but it will take some greenbacks to accomplish this. In contemplating his financial health, he realizes that he has little savings and an investment account that is better left alone.
So, he says to his best friend, “I’ll just take out a mortgage with the bank for $50,000.00.” Mr. X trudges to the bank and completes his loan application. The bank approves the loan on condition that Mr. X agree to offer his home as collateral. Mr. X then attends his closing at Godzilla Title Company.
Step 1: Mr. X and the bank sign the Note. The note is the actual contract between the lender and Mr. X regarding the terms of the loan, interest rates, etc.
Step 2: Mr. X signs the mortgage. The mortgage effectively attaches the underlying debt, as set forth in the note, to Mr. X’s property. The mortgage only acts as collateral for the loan. It grants the lender a lien on Mr. X’s property in the amount of the loan.
I often hear people say they will “take out” a mortgage. That is technically incorrect. The individual or entity “takes out” a loan. Concurrent with the loan, the individual or entity (now the mortgagor), grants a mortgage to the lender. The owner voluntarily grants its land as collateral. The lien created by the mortgage is known as a consensual lien.
Now, if the underlying debt is satisfied, either by its own terms or by early payoff, the lender will discharge its mortgage. When the discharge is properly recorded, the land is effectively removed as collateral.
The mortgage will only become a player if the mortgagor falls drastically behind in its payments. The mortgage lies in wait. It is the heavy artillery used by the lender when all collection efforts fail. I say that the mortgage becomes a “player” because until the lender accelerates the loan, the mortgage offers no immediate remedy for the lender. The lender must accelerate the loan before it can foreclose on the property secured by the mortgage.
There are vast scenarios that can play out through the course of a debtor’s loan. Of course, none of these scenarios become an issue until something goes wrong. Some of these scenarios include: (1) foreclosure by advertisement; (2) judicial foreclosure; and (3) a mortgagor’s bankruptcy.
Summary: This article briefly discussed the nature of a mortgage; what a mortgage is; how it is created; and its benefit to a lender in case of default. I hope this gives the reader an elementary understanding.
In property transactions, the primary instrument of security is the mortgage. The mortgage must be recorded at the register of deeds office in the county where the property is located. Upon recordation of the mortgage, the mortgage is said to be perfected. Perfecting a security instrument (the mortgage) is mandatory if the holder of the mortgage wants to foreclose.