Topic 12.5: Methods of Purchasing Property Encumbered by an Existing Loan >

Learning Objective

After successfully completing this topic, you will be able to distinguish among the various methods of purchasing mortgaged property.

Taking Title to Property with a Mortgage

Most residential mortgages have an alienation (due on sale) clause requiring that the loan be paid off when ownership changes. Because of this clause, buyers must pay cash for the property or obtain a new mortgage loan that will pay off the existing loan. In the few cases where a mortgage does not have an alienation clause, a buyer may take title to the property in one of two ways

• subject to the mortgage, or
• assumption of the mortgage.

Taking title to property subject to the mortgage

When a buyer purchases a property subject to the existing mortgage, the buyer acknowledges the existence of the mortgage, but does not accept personal liability for the debt. The seller remains contingently liable for the debt until it is paid. The buyer will normally want to pay the required payments, or face the loss of the property. If the buyer defaults on the loan and the lender forecloses, the lender may sue the seller for the deficiency (loan amount and costs minus foreclosure sale proceeds). The lender cannot successfully sue the buyer because the buyer didn’t sign the note.

Why would a seller enter a transaction where the buyer takes the property subject to the mortgage? Probably because
1. the seller doesn’t know about the contingent liability involved, or
2. the seller is close to being foreclosed and has nothing to lose.

Taking title to property by assuming the mortgage

When a buyer purchases property and assumes the existing mortgage, the buyer agrees to take personal responsibility for paying the mortgage. This doesn’t relieve the seller from liability, but it gives the lender an additional person who is liable.

The wording in the deed will say something like “Subject to that existing mortgage to Glencove Investments dated July 17, 2014, which grantee expressly assumes and agrees to pay.” The sentence must be read in its entirety. The fact that the first two words say “subject to” doesn’t matter; the last part says “the grantee expressly assumes and agrees to pay.” 

If the loan goes in to default and there is a deficiency, the lender can sue either the seller or the buyer. Most sellers would want to avoid this liability, and can do so by requiring the borrower to qualify to assume the loan. The borrower would then sign new loan documents, including a new note to take over the loan amount, term and payments. The borrower’s note would be marked “paid.” This process is called a novation.

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Contract for deed (land contract) 

A contract for deed is also called an agreement for deed, land contract, or installment contract. It is a method to finance the purchase of property. The difference between a land contract and a deed and mortgage transaction is that the buyer receives equitable title, but does not receive legal title (a deed) until the purchase price is fully paid. The seller retains legal title until the purchase price is fully paid. During the time before the contract for deed is paid off, the buyer is responsible for paying real estate taxes and other expenses of the property.

Why would a buyer agree to use a contract for deed instead of simply getting a deed and giving the seller a mortgage? It may be due to one of two different situations:

1. The buyer does not have a large enough down payment, so the seller is unwilling to give full title until the buyer has paid most or all the purchase price. The deed is delivered only after all payments have been made by the buyer. In case of default, foreclosure proceedings are required in Florida.
2. The seller has a mortgage on the entire property, but is unable to release individual parcels until the entire blanket mortgage is repaid. For that reason, the seller cannot give free and clear title to buyers, and uses a contract for deed so that the buyers are able to get a deed only after the blanket mortgage is paid.

The buyer may lose property if seller defaults on blanket mortgage. There is a real danger to buyers who buy under the second situation. The buyer could conceivably make payments on his or her for several years only to find out that the seller has defaulted on the blanket mortgage. If that happens, the owner of the blanket mortgage can foreclose the entire property and the buyer of the parcel would lose all his or her equity.

Licensees must be wary of selling property under contract for deed. Because of the possibility that the buyer could lose the property, Florida statutes provide consumer protection. It is illegal for a real estate licensee to sell the parcel of property that is encumbered under a blanket mortgage unless the parcel can be released at any time for an amount less than the amount owed on the parcel of real estate. 

Don’t practice law. A contract for deed is a legal instrument that conveys equitable title, and must be prepared by an attorney. Real estate licensees may not prepare a contract for deed, or else they may be charged with unauthorized practice of law.

Normally, the contract for deed is not recorded. This leaves the buyer at risk for any judgments or liens against the seller. The buyer should insist that the document be acknowledged so that he or she can record the instrument.