Buying a home is an involved process, and can be stressful for even the most seasoned real estate professional. For the average home owner who needs to borrow money in the form of a mortgage to purchase a home, it requires a lot of know-how to make sure that they are protected and that everything is completed correctly.
If you are buying a home in one of several states that still observe the common law theory of mortgages (or “title theory”), it is important to become familiar with the defeasance clause of your paperwork. It can make all the difference when prepaying a mortgage if you are in a state operating under the title theory.
What Is a Defeasance Clause?
In real estate speak, a defeasance clause is a provision in a mortgage that allows the borrower to redeem the property upon payment of all obligations to the lender. This means that only once the entire principal and interest of the mortgage is paid can the borrower claim the title to that property. More simply put, the lender must surrender the title to the property once the borrower has satisfied their financial obligation in full. If you are the borrower, though, watch out for possible prepayment penalties in that defeasance clause.
In states that follow lien theory for mortgages, a defeasance clause is not necessary. That is because under lien theory, the mortgage itself is a lien on the property instead, and the borrower retains the title to the property. The lender only recoups the title if the borrower forecloses on the home.
Who Uses Defeasance Clauses?
Generally speaking, who uses a defeasance clause depends on which state the buyer resides in. Approximately half of states are title theory states, and thus, use a defeasance clause. About half of states are lien theory states and do not require a defeasance clause in the mortgage paperwork.
The individuals who ultimately use the defeasance clause itself are the ones writing the mortgage, such as a bank or credit union. In title theory states the mortgage will include a defeasance clause indicating that the title will remain with the bank and the borrower will receive the title from the lender once the loan has been paid in full.
How Does a Defeasance Clause Help You?
If you are a bank writing a mortgage, it is critical to understand whether the property is in a title theory state or a lien theory state, so the paperwork can be completed accurately. For states that operate under title theory, and thus, involve defeasance clauses, it makes it somewhat easier for the bank to foreclose on a home. In lien theory states, the title remains with the borrower, and that makes a foreclosure more complicated.
If you are the purchaser of a property in a title theory state, a defeasance clause clearly lays out your rights and responsibilities to the mortgage and the title. The lender will retain the title, but it is legally required that the lender turn over the title to the property owner as soon as the loan obligation is met in full.
Mortgages are complex documents and understanding the mortgage theory under which your state operates is crucial. If you are unsure, consult a lawyer or your realtor. Whatever you do, do not sign the dotted line on a mortgage without having a clear understanding of your legal rights and responsibilities.
Defeasance Clauses: Tips For Getting It Right
- Understand whether you are in a title theory state or a lien theory state. If you are in a lien theory state, then you’re done – defeasance clauses don’t apply to you. Consult with your realtor, your bank, or even do a quick internet search to help you figure out which one applies to you.
- If you are, indeed, in a title theory state, then make sure you have reviewed the defeasance clause in its entirety. It should indicate that upon payment in full of the loan, the lender will surrender the title to the borrower. This is important whether you are the borrow or the lender.
- Know your rights. Whether you are the borrow or the lender, you have rights and responsibilities when it comes to the property, the title, and the mortgage. As the lender, you have the right to retain the title while the borrower is still paying the loan back. As the borrower, you have the right to the title as soon as the loan is paid in full.
- Check the defeasance clause for prepayment penalties. Prepayment penalties are not always applicable, even in title theory states, but if you are the borrower then it is critical to understand whether you will have a penalty for paying off the loan earlier than scheduled.
5. Review everything. Consult a lawyer, use a respected realtor, and work with a local branch or credit union with whom you already have a relationship if possible. Trusted partners are invaluable in your search for a new property.
6. Purchase your property, and enjoy it!
Defeasance clauses are only applicable in about half of all states – those that operate under the title theory of mortgage lending. It’s easy to figure out if this applies to you or not, and whether you are the borrow or the lender, you will want to know ahead of time whether that title goes home with the borrower or stays with the lender until the loan is satisfied. If there are issues, questions, or concerns, always consult with a professional before signing any paperwork.
Let us know what you thought of this article. Do you have experience with defeasance clauses, or know someone who does? Feel free to reach out and share your experience, or comment below.