The most common ways homebuyers finance home purchases are with mortgages. A mortgage is a legal encumbrance on property – it is a loan for which property is the collateral. The lender loans money which must be paid back, with interest, over a set period. The lender does not have the right to enter or possess the property so long as the borrower complies with the mortgage agreement’s terms.

The first benefit of a mortgage is that mortgages are typically available with much lower interest rates than other types of loans. As of this writing, the average mortgage rate for a 30-year fixed mortgage is about 4.5% Contract that with credit card interest rates, which are typically well over 10% and can be as high as 24% or even higher.

Because real estate typically appreciates, on average, at a rate of more than 5% per year,[1] low mortgage rates encourage home ownership since expected appreciation is often more than the mortgage interest paid for the investment. Moreover, except in the case of very expensive homes, mortgage interest qualifies as a Schedule A tax deduction, further encouraging home ownership through this tax break. In all, Americans hold over $14.5 trillion in mortgage debt, and this sum keeps increasing.[1]

While the borrower makes monthly payments to repay the loan, he can use and occupy the land.

Creating a Mortgage-Promissory Note

A borrower executes at least two instruments to create a mortgage: a promissory note and a security agreement.  A promissory note is a written document that guarantees a lender’s right to be repaid the underlying debt. The document contains a written promise to pay a predetermined amount to the lender at a specified date or schedule of dates. A promissory note can be bought and sold, and when the lender transfers it, the debt under the agreement is unaffected.

Most states have usury statutes, which penalize lenders for charging excessively high interest rates. For example, in California, an interest rate cannot exceed 10% per year. Lenders are responsible to be aware of the rights and limitations that apply in their states.

Creating a Mortgage-Security Agreement

While the promissory note is the document that contains the promise to repay the loan, another security instrument is needed to establish a lien on the real property purchased. A security agreement designates the property as collateral for the loan[7] and conveys legal title from a borrower to the lender as security for the mortgage loan.

A security deed is a two-party instrument.

Other Security Interests

Deed of Trust

Another possible financing strategy is to execute a deed of trust. A deed of trust is like a mortgage because it pledges real property to secure a loan. However, unlike a mortgage, where title to the collateral remains in the debtor and creates a lien on the real estate in favor of the creditor, a deed of trust conveys title to a third party known as the “trustee.”  The trustee holds the title in trust with the lender designated as the beneficiary.

Securing a Loan with Personal Property

A borrower can secure a loan by using personal property with substantial value. For example, a borrower can use items such as jewelry or art work as collateral. Article 9 of the Uniform Commercial Code, a uniform commercial law adopted in every U.S. state, regulates secured transactions.

Under Article 9, a borrower signs a security agreement conveying a security interest in personal property to the lender and then files a UCC-1 financing statement. A financing statement itself won’t create the lien or security interest, but when properly filed, it gives notice of the security interest created in the security agreement.

The UCC financing agreement will describe the borrower’s collateral, describe the obligation it secures, identify what constitutes a default, the rights of the creditor if the borrower defaults, the requirements of the debtor with respect to the care of and insurance maintained on the collateral, and any other obligations in the transaction.

Once she files the financing statement with the appropriate government office, usually the secretary of state, the lender has a security interest in the personal property and if the borrower defaults, the holder can take possession of and to sell the collateral apply the proceeds to the loan.

Guaranty Agreement

When a borrower doesn’t have an extensive credit history or if she poses additional financial risk, a bank may also require a co-signer to support the agreement to reduce the credit risk. Called a guaranty, it gives a lender the right to sue a third party, the guarantor (or co-signor), who signs an agreement to step in to pay back the borrower’s debts if he defaults.[11]

There are two categories of guaranty notes which dictate how and when the third-party guarantor will pay a lender. The first is a “payment guaranty” wherein, as soon as the borrower defaults, the guarantor’s obligation becomes fixed and she must pay the lender directly.

The second category, a “collection guarantee”, requires the guarantor to pay the lender only after the lender has pursued legal action against the borrower and has obtained a judgment for the outstanding balance that has been unsatisfied, or the borrower is insolvent, so a judgment ordering the lender to pay isn’t worthwhile.

Whenever there is a guaranty note, the guarantor must consent before changes can be made to it or to the mortgage agreement.  The guarantor’s consent is necessary because modifying or amending the mortgage agreement in any way could substantially impact his rights and liabilities.[12]

Common Contractual Terms in Mortgage Agreements

Promissory notes and security agreements, together, create a mortgage between a bank and a real estate buyer.

  1. Dragnet Clause

A mortgage agreement’s dragnet clause secures all debts that the borrower may owe to the lender at any time. The clause also applies to late fees and other costs that are due to the bank.

  1. Due on Sale Clause

A property owner who has taken out a mortgage can sell her property even if she still has numerous mortgage payments to make. However, a mortgage agreement can inhibit the free transfer of property if the underlying agreement includes a “due on sale” clause.

Such a clause will affect both a borrower and a lender if a property owner wants to sell the property without having paid back the entire loan. This clause allows the existing lender to call the entire loan due and payable if the homeowner transfers title to the home without paying the loan in full.

 However, it should be noted that federal law, under the Garn–St. Germain Depository Institutions Act of 1982, disallows the enforcement of due-on-transfer clauses when the transfers are made to certain close relatives.[2]

  1. “Subject to” or “An Assumption of” Mortgage Default Terms

If there is no due on sale clause, mortgages are easily transferrable.  A transferable mortgage, also called an assumable mortgage, is a loan that one party can transfer to another. The lender puts the loan in the transferee’s name; the transferee takes responsibility for repayment under same interest rate and other terms the original borrower had.

Though the mortgage can be transferred, its language determines subsequent purchaser’s potential liability for the original borrower’s debt. The key words here are “subject to” or “an assumption of.” If the property can be transferred “subject to” a mortgage, the new owner cannot be held personally liable for the underlying debt.  If the subsequent holder of a “subject to” mortgage defaults, the lender can foreclose on the property will be foreclosed but the lander cannot sue him for any remaining amount due on the debt after public sale. Rather, the lender can recover any remaining damages from the original borrower.

Subsequent Mortgages on the Same Property

A borrower may want to take out a second mortgage on his property.  Unless the first mortgage agreement expressly prohibits him from doing so, he can mortgage his property as many times as he wants. It’s risky for a lender to issue a second mortgage because the second mortgage terminates if the borrower defaults on the first. Every subsequent mortgage is inferior to the prior.

To mitigate this risk, the issuer of a second mortgage often requests estoppel certificates requiring the first mortgage holder to give notice of an impending default and give the second mortgage holder an opportunity to cure and prevent foreclosure.[15]


If a borrower fails make mortgage payments in a timely manner, the lender has several options. Foreclosure is the most widely-recognized consequence for failing to pay a mortgage when due. However, foreclosure is an extreme remedy for default and a defaulting borrower has contractual and due process rights before a lender can begin foreclosure.

Borrowers default for a variety of reasons. Depending on where the property is, a foreclosure can be either court-ordered or accomplished through contractual power of sale. A court-ordered, or judicial, foreclosure requires the lender to file a lawsuit against the borrower in default.

Judicial action is the sole foreclosure method in some states.

In jurisdictions that do not practice judicial foreclosure, the mortgage holder has a contractual power to foreclose and sell mortgaged property. While a court won’t review this sale, states impose strict standards on non-judicial foreclosures.

Federal and State Limits on Foreclosure

Several states have enacted laws permitting a mortgage borrower to recover it even after a foreclosure sale. This post-foreclosure redemption can only be exercised for a limited amount of time though, and laws vary by state. Following the mortgage crisis of 2008-2009, many states passed laws limiting the rights of lenders to foreclose on residential property.

These laws often impose waiting periods of up to 120 days before a lender can foreclose on a property.



[1] U.S. Federal Reserve, “Mortgage Debt Outstanding,” Board of Governors of the Federal Reserve System (Sept. 21, 2017)

[2] Conley v. Barton, 260 U.S. 677 (1923)

[3] See e.g. Livonia Property Holdings, L.L.C. v. 12840-12976 Farmington Road Holdings, L.L.C., 717 F. Supp.2d 724 (E.D. Mich. 2010) (holding that a mortgage cannot exist separately from the underlying promissory note).

[4] Uniform Commercial Code § 3-104.

[5] Renuart, E., Uneasy Intersections: The Right to Foreclose and the U.C.C., 48 Wake Forest L. Rev. 1205, 1216-17 (2013).

[6] Hinkel, D.,Essentials of Practical Real Estate Law 186 (6th ed. 2016).

[7] Renuart, E., Uneasy Intersections: The Right to Foreclose and the U.C.C., 48 Wake Forest L. Rev. 1205, 1212 (2013).

[8] Supervisor of Assessments of BaltimoreCounty v. Greater Baltimore Medical Center, Inc., 202 Md. App. 282, 32 A.3d 174 (2011).

[9] Hinkel, D., Essentials Of Practical Real Estate Law 189 (6th ed. 2016).

[10] Id. at 196.

[11] See Ameris Bancorp v. Ackerman, 674S.E.2d 358 (Ga. 2009), cert. denied, (June 1, 2009).

[12] Hinkel, D., Essentials Of Practical Real Estate Law 188 (6th ed. 2016).

[13] See e.g. Livonia Property Holdings,L.L.C. v. 12840-12976 Farmington Road Holdings, supra note 4.

[14] Boyette v. Cardin, 347 So.2d 759 (Fla. 1977).

[15]Hinkel, D., Essentials Of Practical Real Estate Law 194 (6th ed. 2016).

[16] Renuart, E., Uneasy Intersections: The Right to Foreclose and the U.C.C., 48 Wake Forest L. Rev. 1205, 1212 (2013).

[17] Nelson, G., Reforming Foreclosure: The Uniform Nonjudicial Foreclosure Act, 53Duke L.J. 1399, 1405 (2004).

[18] Hinkel, D., Essentials Of Practical Real Estate Law 198 (6th ed. 2016).

[19] Arkansas Foreclosure Laws,

[20] Id at 199-201.

[21] Homeowner Affordability and Stability Plan, P.L 111-22 (May 20, 2009).