Most of us wander through life unconcerned about the vagaries of house finance laws until we decide we want a house. Candidly, because of how house purchases come about, most of us don’t know much about mortgage financing even after we buy a house or two. So here’s a primer.
You are in your twenties or perhaps early thirties. Everyone tells you how inefficient it is to rent. You must buy a house so you can deduct the mortgage payments and real estate taxes. So, you do. You and your spouse or “partner” apply for the mortgage. Sometimes that can be a revelation when word comes back that one of you has a financial history of bad credit or bankruptcy. All you know is that you want to buy the house and you don’t much care about what the paperwork looks like.
Most people think a mortgage is one thing; it actually is more like two. When you go to a real estate closing you sign what seems like a hundred documents. One of those documents is called the “note” (actually a promissory note). It says you agree to pay the lender a fixed or variable amount of money to pay off the house over 15 or 30 years. It is a promise to pay and is enforceable by a contract action. The note is essentially a complex “I.O.U.”
Then, in the sea of other documents you sign there is a document called a “mortgage.” The mortgage is essentially an acknowledgement by the buyers that the lender has a “lien” on the house you bought. The most common lien is a home mortgage but liens can also arise from failure to pay your income or real estate taxes or judgments by creditors. The lien is recorded in your local courthouse and if you try to sell the property, the lien is notice to the buyer and the world that other people have to get paid their lien interest before the seller sees any money from the sale. Liens that exceed the selling price actually block your ability to sell unless the lienholders release their lien interests. That’s for another day, but it happens when real estate prices drop (yes, that has happened).
You and significant other/spouse agree to buy the dream house. Word comes back that there are problems with your partner’s credit history. Often the lender will say they don’t want that partner on the note. Or sometimes, your partner says “I want to own the property but I can’t be on the debt because of …(fill in the blank).” In these cases, you may be able to go forward and close the transaction to acquire the house with only one partner on the note. But, the same lender is going to insist that you both sign the mortgage document. Why? Because if there is a default the mortgage instrument says that despite whatever the note says or whoever signed it, you both understand that if, as, when the property is sold the lender gets paid first. That’s ahead of anyone else claiming money is owed. If you fail to pay the note or do something else to mess with the lender’s interest (all set forth in the “note”), your lender is entitled to sue you to force a sale of your home so that lender can recover the money it loaned to you in good faith. This is called a foreclosure action. It is brought against both buyers who took title even though only one signed the note to pay the lender back. If your lender successfully sues you in foreclosure, your house is sold by your friendly county sheriff at a public auction. When he does that, the now unfriendly sheriff comes to your house and kicks you out of it, assuming you have not moved on. The sheriff collects the auction price from the highest bidder and pays off the judgment creditors with those proceeds. That includes your mortgage lender. If there is any money left over, the sheriff will send it to you. Then he prepares a sheriff’s deed conveying title to your house to the man/woman or entity who bought your house at the auction.
Let’s say you are the person not on the promissory note, but you did sign the mortgage and you are on the title to the dream house. You might have done that because your credit was bad or because you needed to keep your debt level low so that you could buy a business or borrow for some other transaction. Meanwhile, during the time you and your partner lived in dream house, you dutifully paid half the expenses to your partner including the monthly mortgage and real estate taxes. Sadly, your partner didn’t pay the mortgage with the money you gave him. Now, there is a foreclosure by the lender because of your partner’s failure to pay. Unless someone steps forward (e.g., you) to make the lender whole, the foreclosure will proceed and you can’t stop it because you signed the mortgage that sublimated your rights to the house to the interests of your partner’s lender.
We are seeing lots of couples both married and not who are buying real estate without lawyers and going to settlement where they sign documents that could be financially ruinous unless the buyers play fair and keep the lender happy. Realize as well that many lenders who are holding loans bearing 3-4% interest might, over time, grow aggressive about enforcing their contractual rights in order to adjust the interest rate. Example: you don’t pay your real estate taxes on time. The school district files a lien. That’s a technical default of the note/mortgage. Lender demands that you sell. You respond by paying the taxes. But the lender says no, you must sell because you defaulted even though you cured the default. The lender is within their legal rights to foreclose. But, that lender might be willing to allow you to cure the problem if you would agree to pay a “fair” interest rate; say 7%. Is that ok? We’ll see. Your real estate closing to buy the dream home was not just a test of your penmanship. Those documents can come back to bite you.