Real Estate often serves as the primary collateral for a loan, and for good reason. Compared to personal property, real estate tends to depreciate less, cannot be absconded with, and oftentimes is simply more valuable than items of personal property. For this reason, lenders usually take significant efforts to ensure they obtain a first priority lien against the real estate, including obtaining title opinions or title insurance. Challenges can arise where a borrower needs more credit in the future or the parties want to modify or extend the loan in the future; some actions can impact the priority of the mortgage when there have been subsequent liens or mortgages against the property.
Extending New Credit
In the most basic transaction, a customer borrows a fixed sum secured by a mortgage, repays the principal and interest usually over a number of years, and the mortgage is satisfied. Many loans do not follow this pattern and instead may involve partially paying the original amount down, borrowing more later, or even combining or consolidating multiple loans over time. Other transactions are devised from the outset as revolving lines of credit, contemplating a fluctuating principal throughout the life of the loan. Each of these circumstances may lead to slightly different results in a dispute between lienholders down the line.
Of course, the basic rule is that the first mortgage or lien of record has priority up to its maximum principal amount over a subsequent lien and will be able to wipe out junior liens in the event of a later foreclosure. But whether that mortgage will remain in a senior position over subsequent liens in the event of an advance of new credit depends on the terms of the original mortgage and the circumstances of the new funding advanced.
As a general rule, even with a mortgage that contains a future advance cause—providing that the mortgage secures not only the existing debt, but all other future advances by the lender to the borrower—a subsequent lienholder may have priority over those new advances if they were optional, as opposed to mandatory, under the terms of the note and mortgage. For example, if a lender voluntarily enters into a second loan with the borrower, relying on the existing mortgage with a future advance clause as security, the mortgage may only have priority over an intervening lienholder as to the original principal balance, because the new loan was an optional advance of new funds.
On the other hand, if a lender enters into a transaction such as a construction loan, subsequent advances will take priority if they are mandatory under the original transaction. In most construction loans, the lender agrees to advance funds as construction progresses, provided certain conditions are met. These subsequent advances will have priority over subsequent liens and mortgages against the property, because the lender is obligated to advance those funds.
The exception to this mandatory-verse-optional advance rule lies in revolving lines of credit. A mortgage which expressly secures a revolving line of credit will retain its same priority as to all amounts outstanding regardless of the time of payments and regardless of whether new advances are mandatory or optional under the loan agreement.
Extensions and Renewals
Mortgages can be given as security for relatively short term debts, such as operating notes or other business debts. For a variety of reasons ranging from a borrower’s financial difficulties or a just a desire to extend the lending relationship, a lender might agree to extend the maturity date or renew the note.
Generally, maturity date extensions and note renewals do not impact priority of a recorded mortgage, particularly if the mortgage includes language (most do) specifying that it is intended to secure not only the original note, but all extensions and renewals thereof. Because there is a statute of limitations, limiting the timeline to foreclose a mortgage to fifteen years from the maturity date stated in the mortgage, it is a good idea to place the new maturity date of record. It is typically better practice to record a modification of the existing mortgage noting the extended maturity date, rather than satisfying the old mortgage and recording a new one. While courts occasionally rely on concepts of fairness and equity to treat a replacement mortgage as having the same priority as the existing, this is not a guaranteed outcome, and lenders in Minnesota have found themselves behind intervening liens when replacing one mortgage with another.
Interest Changes and other Amendments
Interest rates are another term that may be changed throughout the course of a lending relationship, either because the initial note has a variable or adjustable rate term, or because the interest rate is voluntarily changed through a renewal or modification. A change of interest rate for the underlying debt will not typically impact a mortgage priority. In fact, this often does not implicate the mortgage directly, because the recorded mortgage in many cases does not specify the interest rate of the corresponding note and rather simply indicates that the mortgage secures principal and whatever interest accrues. If a mortgage does include a stated interest rate, a modification of mortgage can be recorded, noting the change of interest rate.
There can be a panoply of other changes and amendments that might be made to an existing mortgage. Whether any particular change will impact the mortgage’s priority for some or all of the debt will depend on the facts and circumstances of each case. Generally, disputes over whether an amendment or change affects a mortgage’s priority are not answered by a specific statute, but rather by courts analyzing the circumstances around the change, so it becomes difficult to make a firm conclusion unless a court has already analyzed the exact situation before. Courts often look at whether the change is “materially prejudicial to the holder of a junior interest,” but it a challenge to know how this rule might be applied in the future. For amendments beyond extensions and interest rates changes, it may be wise to complete an updated title search to ensure there are no intervening lienholders who could raise a dispute in the future.
Having a first position mortgage is obviously an advantageous position for a lender when entering into a loan, but as the lending relationship evolves over time, keeping that position is just as important. Lenders should take care to ensure extensions, modifications, and expanding credit do not impact their mortgage priority over time.