Be Careful When Giving Your Debtor a Break
Suppose you own a note secured by a mortgage or deed of trust (for convenience, I will refer to both as a “mortgage”).
It would not be terribly unusual for the debtor to come to you for some relief if he’s having trouble making the payments. He might want the interest rate lowered, the payments amortized over a longer period, or a balloon payment postponed. Being a reasonable person, you might be inclined to work out a deal-after all, it’s better than foreclosing-but you would probably ask for something in return. For example, you might agree to forgive a couple of past due payments or maybe postpone them until the maturity of the note, but in return you might want to increase the interest rate a point or two.
This raises two legal questions:
- Is such a modification enforceable?
- Does it affect the priority of the mortgage?
Enforceability. The answer to the first question is easy-the modification is enforceable if it is clearly agreed upon between you and the debtor, even if there is a junior mortgage on the property. The best practice, of course, is to put it in writing and record a modification of mortgage.
Priority. The second question is more difficult, and this is where problems can arise. If the debtor has put another mortgage on the property that is junior to (later than) yours, you need to make sure that the modification of the note does not cause your mortgage to lose priority-that is, to become junior to the junior mortgage. If this happens, your mortgage is still enforceable-it just becomes a second mortgage instead of a first mortgage. You definitely want to avoid this.
Two rules govern this situation.
RULE NO. 1:
If the modification does not make the loan more onerous to the borrower in any way, your mortgage retains its priority. Thus, if you grant concessions but take nothing in return, your priority remains intact. An example might be stretching out the payment schedule but leaving all the other terms the same. However, if you trade a concession for a benefit-for example, if you lower the monthly payments in return for an increase in the interest rate-you may lose priority, in whole or in part, even if the restructured loan, taken as a whole, is more favorable to the borrower. In most cases, priority is lost only to the extent the loan becomes more onerous, such as the amount of additional interest that becomes payable. However, in some cases, where the overall change endangers the junior lender’s security, the priority of the entire mortgage may be affected.
There is an exception to Rule No. 1: If the mortgage specifically allows modifications to the note, priority is not lost, even if the restructured note is more onerous (see the sample language below). This exception is not available in every state, so legal counsel should be consulted before relying on this exception.
Warning to Junior Lienholders. If you are about to accept a junior mortgage, review the first mortgage carefully. If it contains a provision allowing the note to be modified, you are on notice that the senior obligation may be increased or made more onerous in some manner, which could endanger your security.
RULE NO. 2:
If the junior lienholder consents in writing to the modification and agrees that it will not affect his priority, then it won’t. This consent should be recorded.
Conclusion. It will not hurt your legal position to give your debtor a break as long as you receive nothing in return. If you do want to receive something in return, it is best to order a title report to find out if a junior encumbrance has been placed on the property that could affect your priority. If so, you should seek legal counsel to make sure the transaction is handled in a way that will not adversely affect the priority of your mortgage.
If you are accepting a junior mortgage, read all senior mortgages carefully to determine whether there is any provision that could allow the obligations secured by the senior mortgages to be enlarged. If so, you will need to take steps to eliminate the possibility that your security could be impaired by a modification to a senior mortgage.