A Halfway Improvement In The Ancient Law Of Mortgages

Published by Forbes.com | September 20, 2024

Updating archaic mortgage laws has rarely been a priority for the justice system, however a new proposal might just bring about some long overdue change.

Owners of commercial real estate and their mortgage lenders often agree to amend the terms of their loan, in minor and sometimes major ways. The traditional law of mortgages complicates all those amendments for no good reason. Those complications are driven by blind adherence to ancient principles of mortgage law that should play no role in modern real estate finance transactions.

More specifically, after the borrower and lender close their original loan and record their mortgage, someone else might theoretically record another mortgage or some other lien or claim against the same real property (any of those, a “junior-priority lien”). If the borrower and the first lender amend their loan, the first mortgage might lose its first priority and become a second-priority mortgage, with lower priority than the junior-priority lien – a very bad result for the first lender. That could happen if the loan amendment somehow made the loan more burdensome, such as by increasing the loan amount or the interest rate. This would, according to the law of mortgages, unfairly hurt whoever holds a junior-priority lien. Therefore, the first lender should lose priority as punishment.

None of that makes any sense in the real world, of course. Commercial mortgages typically prohibit the borrower from creating any form of junior-priority lien. Future lenders rarely accept junior-priority liens, although other types of claims might get recorded involuntarily.

In the rare case where a second lender wants to (and can) record a junior-priority lien, the first thing it will ask for is a certificate from the first lender, confirming the status of its mortgage and disclosing any amendments to date. The second lender isn’t going to assume anything about the previously recorded first mortgage. Any requirement to record mortgage amendments doesn’t add much.

Given the treatment of mortgage amendments under traditional mortgage law, whenever a mortgage lender agrees to any loan amendment, they often take two extra steps. First, they check for junior-priority liens. Then they record a mortgage amendment just to avoid any possible risk that their mortgage might become subordinated to future junior-priority liens. That recordation triggers a discussion of whether the mortgage lender should obtain new title insurance, which can trigger significant premiums. Even if the first mortgage expressly states that it might be amended later without loss of priority, a conservative first lender and its conservative counsel will still worry about potential loss of priority to junior-priority liens.

Any state legislature could easily eliminate this entire issue and the resulting headaches. They could simply pass a law confirming that if a recorded mortgage says it secures all future amendments, then the recorded mortgage secures all future amendments, even major ones, with no risk of lost priority (a “priority protection law”). Such a law would allow the holders of first mortgages to stop worrying.