What Is a Defeasance Clause?

A defeasance clause is a provision of mortgage contracts indicating that the borrower will receive the title to the property once all of the mortgage payments have been made on time.

In some states, it is common for a mortgage loan agreement to include a defeasance clause. This clause states that full title to your mortgaged property transfers to you only after your mortgage is paid in full. 

However, a mortgagee who lent money to a mortgagor received in exchange a deed of a defeasible fee to the property, offered as security for the payment of the debt and, the such title was subject to defeat or cancellation upon payment of the debt on the law day, the mortgagor would then regain title to the property.

Defeasance clauses are not found in mortgages based on lien theory, rather the mortgage creates a lien for the mortgagee on the mortgaged property and this gives the mortgagee the right to possess the property whenever the mortgage is been foreclosed.

If you want to know more about the defeasance clause, I urge you to keep on reading this article.

How a Defeasance Clause Works

Defeasance clauses are part of how mortgage law determines who is entitled to the property. for instance, when you get a new home, it feels like the property belongs to you in the sense that they make the decisions about modifying the property since you are the one who lives there.

However, the lender can retain the ability to take possession of the home and sell it to recoup their losses through foreclosure in instances of non-payment.

The defeasance clause works through the actual language in the loan documentation and the laws of that state. In states that subscribe to title theory in their laws, defeasance clauses pave the way for a lender to use judiciary foreclosure through the courts if the borrower defaults on their mortgage before paying completely.

How Does Defeasance Clause Works in Real Estate?

Defeasance theory works in real estate when the secured title is a title to property that is held by the lender as security for a loan. In the event that the borrower fails to repay the loan, the lender has the right to take possession of the property and sell it in order to recover its losses.

Although, states differ in how that process works. In states that follow “lien theory,” the borrower holds title to the property, but the lender holds a “lien on the property” and this can be foreclosed, if the borrower defaults. For states that follow the “intermediate theory,” the borrower also holds title to the property, but the title reverts to the lender in the event of a default.

The defeasance clause in a mortgage is important, as it allows the borrower to repay the mortgage early without losing their secured title or secured mortgage. This clause is important, as it gives the borrower flexibility to repay their mortgage without penalty. Defeasance clauses are based on the concept of defeasance which nullifies a contract.

How Defeasance Clause Works in Mortgage

A mortgage agreement is a detailed outcome when a given situation occurs. It allows both the mortgagee and the mortgagor the right to seek legal remedy if those conditions are not met. a mortgage agreement outlines when payments are due and what happens if the borrower misses a payment.

Therefore, defeasance is documented legally to safeguard your rights as a home buyer; it’s lawfully binding terminology that states that if you pay off the house loan, you will own the property outright and complete. But, it depends on the state where you live and how they interpret an aspect of real estate law called mortgage theory.

Each state has its own mortgage law theory which is: the Lien theory, Title theory, or intermediate theory this helps to determine whether a defeasance clause is necessary.

Lien Theory

Lien theory is a defeasance clause in a mortgage agreement that is not required in many states. However, by accepting the mortgage agreement, the borrower grants the lender a lien on the property. In a lien theory state, upon signing the mortgage contract, a borrower also signs a security deed which gives the bank legal title of the property, with the borrower retaining the equitable title.

If the borrower fails to pay or defaults on the loan, the lender can take possession of the property by starting and completing a foreclosure process. When it comes to lien theory, the lender is not granted a defeasible title.

States that are considered lien theory states are: Arkansas, Connecticut, Delaware, Florida, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, New Mexico, New York, North Dakota, Ohio, New Jersey, Pennsylvania, Puerto Rico, South Carolina, and Wisconsin.

Title Theory

Title theory, which means the lender holds the home’s title (or the ownership claim) until the borrower has paid off the loan. A mortgage contract typically includes a defeasance clause in title states so the borrower gets full and clear ownership of the home once they pay off the loan.

Foreclosures in title states must go through a judicial process, which can be costly and time-consuming for both the lender and the borrower. In these states, the mortgage paperwork should contain a defeasance clause. The defeasance clause is necessary to ensure that title to the property will transfer once the mortgage is settled.

States that are considered to be title theory states are Alaska, Arizona, Colorado, Georgia, Idaho, Washington, Texas, Mississippi, Oregon, Nebraska, Nevada, North Carolina, South Dakota, Tennessee, Utah, Virginia, and West Virginia.

Intermediate Theory

An intermediary theory is a sort of middle ground, whereby the borrower keeps the title, but the lender can take it all back if the borrower defaults on the loan. This can be done without judicial proceedings. Intermediate states essentially employ lien theory unless the borrower defaults.

States that are considered intermediate theory states are: Alabama, Hawaii, Maryland, Massachusetts, Michigan, Minnesota, Montana, New Hampshire, Oklahoma, Rhode Island, and Vermont.

Lien Theory vs Title Theory

Real estate laws differ by the state regarding mortgage law theory and the defeasance clause, but they generally fall into one of two categories when it comes to mortgage law theory: lien theory or title theory.

• Title Theory states: The bank retains ownership of the home until the loan is paid off.
• Lien Theory states: The person buying the property owns it, but when the buyer takes out a mortgage, the bank creates a property lien against it.

The main difference between the two theories is when foreclosure proceedings need to occur. In title theory state, that foreclosures must go through court. While In a lien theory state, foreclosures are non-judicial and managed by a trustee, basically without the involvement of the court system.

However, it’s more difficult for a bank to evict you from a home where you have an equitable title (lien theory states) than it is to evict you from a home where the bank owns the property outright (title theory states), and you’re paying off debt.

Defeasance Clause Real Estate: Understanding Secure Title

There are two types of loans which are: Secured and Unsecured

Unsecured debt is typically seen on smaller-balance financial products such as credit cards. Most lenders ask borrowers to put up collateral to obtain substantial sums of money for expensive purchases like a home.

In most home purchase transactions, a buyer obtains a mortgage to purchase the home and secures the mortgage loan using that same property as collateral. With a secured mortgage the borrower is granted loan defeasance and a clear house title is given when borrowers can fully return their interest payments, principle, and any additional payment conditions on a secure mortgage.

In lien theory state, the security deed is used to “protect” the mortgage rather than the property itself. A security deed is employed to transfer legal ownership from the borrower to the bank at closure.

However, the defeasance clause comes down to legal semantics, and it all depends on how the state in which you live interprets real estate ownership concerning the law. You can look into your legal rights and what you’re entitled to (legally) if your mortgage loan is foreclosed.

Advantages and Disadvantages of the Defeasance Clause

Here are the advantage and disadvantages of the defeasance clause that you need to take note of before making any decision.

Advantages	Disadvantages
defeasance provision would lawfully obligate the lender to give a clear title to the borrower on the house once the debt is paid off, which is the most significant benefit for a borrower.	The borrower does not have “title” to the property until complete payment is made.
You can potentially become a homeowner or property owner by giving defeasance right to the lender until the loan is paid in full.	If the borrower fails on the mortgage at any point, the lender can have full possession of the property.

Conclusion

The defeasance clause protects mortgage borrowers in title theory states. It works mostly in their favor because, it lets them claim full ownership of the property transferred from the lender, once the loan repayment condition is complete. The mortgage agreement is null and void when the loan has been paid in full.

Defeasance clauses are not found in mortgages based upon the lien theory, observed in most states. The mortgage creates a lien for the mortgagee on the mortgaged property, which gives the mortgagee the right to its possession only after the mortgage has been foreclosed.

However, a defeasance clause isn’t necessary for every state, though it’s important to read your mortgage agreement for all of the terms and conditions before signing.

Defeasance Clause FAQ

Reference

• investopedia.com
• realestatelicensewizard.com
• encyclopedia.com

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