|Suppose you own a note secured by
a mortgage or deed of trust (for convenience, I will refer to
both as a "mortgage"). It would not be terribly unusual
for the debtor to come to you for some relief if he is having
trouble making the payments. He might want the interest rate
lowered, the payments amortized over a longer period, or a balloon
payment postponed. Being a reasonable person, you might be inclined
to work out a deal--after all, it's better than foreclosing--but
you would probably ask for something in return. For example,
you might agree to stretch out the payments, but in return you
might want to kick the interest rate a point or two.
Although this seems perfectly straightforward and reasonable,
it can also result in the application of the rule that “no
good deed goes unpunished.”
The problem arises when the debtor has placed a junior lien
on the property, because the modification of your note may
cause your mortgage to lose priority--that is, to become junior
to the junior mortgage. If this happens, your mortgage is
still enforceable--it just becomes a second mortgage instead
of a first mortgage.
Three rules govern this situation:
Rule No. 1 is that if the modification does
not make the loan more onerous to the borrower in any way,
your mortgage retains its priority. Thus, if you grant concessions
but take nothing in return, your priority remains intact.
An example might be stretching out the payment schedule but
leaving all the other terms the same. However, if you trade
a concession for a benefit--for example, if you lower the
monthly payments in return for an increase in the interest
rate--you may lose priority, in whole or in part, even if
the restructured loan, taken as a whole, is more favorable
to the borrower. In most cases, priority is lost only to the
extent the loan becomes more onerous, such as the amount of
additional interest that becomes payable. However, in some
cases, where the overall change endangers the junior lender's
security, the priority of the entire mortgage may be affected.
Rule No. 2 is really an exception to Rule
No. 1. If the mortgage specifically allows modifications to
the note, priority is not lost, even if the restructured note
is more onerous (see the sample language below). This exception
is not available in every state; therefore, legal counsel
should be consulted before relying on this exception.
Warning to Junior Lienholders: If you are
about to accept a junior mortgage, review the first mortgage
carefully. If it contains a provision allowing the note to
be modified, you are on notice that the senior obligation
may be increased or made more onerous in some manner, which
could endanger your security.
Rule No. 3 is simply that if the junior
lienholder consents to the modification and agrees that it
will not affect his priority, then it will not.
It will not hurt your legal position to give your debtor a
break as long as you receive nothing in return. If you do
desire to receive something in return, it is best to order
a title report to see if a junior encumbrance has been placed
on the property. If so, the best advice is to seek legal counsel
to make sure the transaction is handled in a way that will
not adversely affect the priority of your mortgage.
If you are accepting a junior mortgage, read the senior mortgage
carefully to determine whether there is any provision that
could allow the obligations secured by the senior mortgage
to be enlarged. If so, you will need to take steps to eliminate
the possibility that your security could be denigrated by
a modification to the senior mortgage.
A good state-by-state review of this topic is contained in
Restatement of Property Third, Mortgages, Section 7.1 et seq.
Here is the wording for a provision allowing modification
to a mortgage without losing priority: "This mortgage
shall also secure all extensions, amendments, modifications,
or alterations of the secured obligation including amendments,
modifications or alterations that increase the amount of the
secured obligation or the interest rate on the secured obligation."
If you are accepting a first mortgage, try to include this
language in your mortgage so that you will have the flexibility
to restructure the debt if necessary without losing priority.
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