A mortgage loan is an ordinary part of financing today’s home purchase. It transfers a lien — a legal claim on a piece of real estate — to the lender, to secure the home loan. This lien is there to ensure the repayment of the loan.
It’s an age-old concept. As explained by H. W. Chaplin in the Harvard Law Review back in 1890:
When this country was colonized, about A.D. 1600, the law of mortgage was perfectly well settled in England. Theoretically our ancestors brought this law to America with them, and during the one hundred and fifty years from the first settlement to the Revolution, the English rules of law governed all these transactions…
In this time-tested fashion, a mortgage borrower pledges the home as loan collateral. Then, the borrower repays the lender over time until the final mortgage payoff.
A Contract Between Lender and Borrower
The mortgage lender evaluates a loan applicant’s financial activities, debt, and buying power. If the lender approves the application, the borrower gets a specific amount of money for a home purchase. To keep the lender’s risk in check, the home buyer makes a down payment, and in some cases pays private mortgage insurance.
Along with a loan approval comes the lender’s loan commitment. This details (among other things) the amount of loan principal and interest to be paid per month, the interest rate, and the term of the loan.
Once the applicant accepts the loan commitment as written, a binding contract exists. The borrower has entered into a contract to pay off the loan through monthly installments, usually over 15 or 30 years. Each payment includes a part of the loan’s principle amount, plus interest.
☛ To ensure that the homeowner keeps up with required taxes and insurance, an escrow account gets funded by part of the borrower’s mortgage payments. The mortgage servicer manages this account, making tax and insurance payments for the borrower. An escrow account is required when home buyers put less than 20% down on a home.
If, at any point, mortgage borrowers don’t uphold their side of the contractual agreement, then what? Consequences depend on the contract. And a properly written contract is backed up with the authority of state law.
The Lender’s Rights
The lender holds legal rights in a home and its title as long as there is any remaining mortgage for the borrower to pay. When all funds are repaid, the lender returns the mortgage note (example: Pennsylvania mortgage note) to the borrower. This means the lien comes off the title and the deed is free and clear — no longer conditioned on a mortgage repayment.
Before that final payoff, a borrower who fails to perform according to the provisions of the mortgage contract is in default. Default might result from missing a monthly payment; a lapse in homeowner’s or condo owner’s insurance policy; letting the property fall into disrepair; or not paying the property taxes.
Usually, a quick call to the mortgage servicer can rectify an accidental lapse. But if the borrower neglects the matter, the lender has powerful rights. Because a mortgage is a secured loan, the lender can take the home to make itself whole. That is, the lender can foreclose the property, sell the home, and recover the outstanding debt.
That’s a harsh consequence, but it’s part of the contract the borrower signed.
☛ In the standard mortgage, the lender can take the title from the borrower only after a default. But knowledge of state law comes in handy — because this point differs in states using deeds of trust and deed of reconveyance instruments.
Another way the contract could be breached is by the borrower transferring an ownership interest to another party. That action could speed up the loan due date, through a due on sale clause.
The Borrower’s Rights
Using an acceleration clause in the contract, a lender can demand, in certain situations, that the defaulting borrower pay the whole debt at once. To support the borrower’s rights, states set forth limits on acceleration clauses. So, a mortgage company might need to accept late payments or modify the contract to help avert foreclosure.
In 1982, Congress passed the Garn-St. Germain Depository Institutions Act. It addresses acceleration clauses. It deals with the due-on-sale clauses that give lenders the option to accelerate the due date for the borrower’s remaining balance “if all or any part of the property, or an interest therein, securing the real property loan is sold or transferred without the lender’s prior written consent.”
The borrower may be able to keep the loan intact by taking certain actions with the lender’s consent. When a homeowner would like to transfer a claim or interest in the mortgaged real estate to another party, it’s up to the lender to consent — which might involve modifying the loan’s terms and conditions — or to demand a mortgage payoff. It’s typically in both parties’ best interest to save the loan.
The federal law also directs mortgage lenders to warn borrowers before they accelerate the debt. Advance notification gives borrowers a chance to cure their breach of contract. Under longstanding legal principles dating back centuries, a borrower should get a reasonable time to pay before foreclosure becomes absolute.
The Garn-St Germain Act also establishes exceptions to acceleration clauses. The borrower may, for example, transfer an interest in the property with a short-term lease, or to a family member, or to a co-owner with survivorship rights, or in a few other situations listed in the law.
Other Legal Matters
Banks, credit unions, government-sponsored entities, or individual people all issue mortgages. (Sometimes individuals offer each other financing, bypassing institutional lenders, by way of the contract for deed.)
Plenty of contract questions can arise between the lender and the borrower. Sometimes, these involve unfair and illegal dealings between the parties. Here are some prominent examples of legal issues between borrowers and lenders:
- False statements by loan applicants: CoreLogic research indicates that one in 131 mortgage applications shows signs of fraud. Examples? False “proof” of debt or income evidence; identity theft; and applications with false claims that the home will be a primary residence.
- Fraudulent actions by industry professionals: In another kind of deception, mortgage professionals or real estate experts themselves turn to mortgage fraud to get funds from lenders under false pretenses.
- Predatory lending: Unfortunately, there are cases of mortgage lenders seeking out vulnerable borrowers to sign loan contracts with unreasonable loan terms or interest rates. For the most part, the Dodd-Frank Act has put a damper on predatory lending.
- Discrimination: Home loan applicants from minority groups — regardless of educational background, income, and earnings potential — face known biases. Mortgage discrimination is against the law.
If questions arise, the borrower should review their rights as laid out in the mortgage loan contract, then contact the mortgage company and ask for help resolving the matter. Borrowers may also sue lenders for breach of contract or violations of laws. Remedies may include refunds, contract cancellation or modification; or the reversal of negative actions impacting the borrower, and other types of court action.
Looking Ahead: An Industry in Flux
The mortgage industry is in a period of upheaval. It used to be a brick-and-mortar, bank-focused business. Today, financial tech firms have entered the arena. Online mortgage companies now play central roles. By 2018, Quicken Loans had surpassed Wells Fargo as the top U.S. mortgage lender.
The Consumer Financial Protection Bureau slapped Wells Fargo with a record fine for mismanagement, impacting 16 million loans. So, CNBC reports, legal woes have caused Wells Fargo to step back even further from the central role it once played in the mortgage sphere.
Very few people enjoy legal disputes with lenders. But a borrower whose account is apparently being mishandled should consult with a lawyer to review the case and file a legal claim if appropriate. A homeowner with legal questions about mortgage lending should consult an attorney in the state.
Cornell Law School: Mortgage.
H.W. Chaplin in the Harvard Law Review: The Story of Mortgage Law (PDF), Vol. 4, No. 1 (Apr. 15, 1890).
Garn-St Germain Depository Institutions Act of 1982, 12 U.S.C. § 1701j–3.
Deeds.com:What Is a “Due on Sale” Clause and What Does It Mean to Me? (Feb. 15, 2016).