Real estate transactions are often chock full of complex terms, complex jargon and complex concepts. Even a question as simple as whether you or not you own your home after closing can result in a not-so-simple answer. (Hint: It depends on which state you live in.)
The answer to the question of ownership may rest in a defeasance clause. A defeasance clause is language that terminates a lender’s property interest once a stipulated condition (full mortgage payoff) has been met.
In your mortgage agreement, a defeasance clause grants homeowners full ownership of their homes by transferring the home’s title once the mortgage is paid off. However, different states have different legal theories as to when that happens and who holds the title to your home.
Though the concepts of mortgage theory and defeasance clauses can seem intimidating at first, you’ll soon understand what these terms mean and why they’re relevant to you as a homeowner.
Defeasance Clause: What It Is and How It Works
In real estate, a defeasance clause in a mortgage agreement states that the lender’s claim on the property’s title will be nullified and full ownership will be transferred to the borrower once the terms of the mortgage are fulfilled.
However, defeasance clauses aren’t mandated nationwide. They’re only applicable in title theory states.
For example, if you lived in Texas – a title theory state – and you took out a 15-year fixed-rate mortgage, you’d find a defeasance clause in your mortgage agreement.
After 15 years of making all your monthly mortgage payments, you would have fulfilled all your obligations to the lender. Your last mortgage payment would trigger the defeasance clause. And with the mortgage satisfied, the title would transfer from the lender to you.
If you live in one of the 23 non-title theory states, keep reading to learn whether your state is a lien theory or intermediary theory state and what that means for you.
Mortgage Theory, Explained
Mortgage theory determines whether the borrower or lender has ownership over the property. Mortgage theory varies by state, but regardless of which mortgage theory applies to your state, your lender can’t simply take the property away from you unless you fail to make your payments.
However, if you do default on your mortgage payments, repossession by the lender also varies by state.
Three legal theories pertain to mortgages: title theory, lien theory and intermediate theory.
What is title theory?
Title theory means that the lender (also known as the mortgagee) keeps the title to the property until the borrower satisfies all the requirements of the mortgage. If you buy a home in a title theory state with a loan, your lender holds the title of the property until you pay off your mortgage.
What is lien theory?
In lien theory states, the borrower (also known as the mortgagor) keeps the title to the house, but the lender attaches a lien to the property. The lien gives them the right to seize the property if you fail to meet the terms of the mortgage.
If you buy a home in a lien theory state, you hold on to the title as long as you continue making your payments and abide by the terms of your mortgage.
What is intermediate theory?
Intermediate theory is a sort of hybrid approach that features elements of both title theory and lien theory. Intermediate theory allows the borrower to retain the title but gives the lender the right to take the title if the borrower defaults on their loan payments.
If you live in an intermediate theory state, you hold the title of your home (like in a lien theory state). But if you default on your payments, your lender can take back ownership of the title (like in a title theory state).
States That Use Title Theory vs. Lien Theory vs. Intermediate Theory
Now that we understand the three theories that designate who retains title to a property, it’s helpful to know which mortgage theory applies to your state. Check out the list below to find out.
Title theory states
- North Carolina
- South Dakota
- Washington, D.C.
- West Virginia
Lien theory states
- New Mexico
- New York
- North Dakota
- New Jersey
- South Carolina
Intermediate theory states
- New Hampshire
- Rhode Island
An Alternative Use of the Defeasance Clause
Though defeasance clauses are commonly found on mortgages issued in title theory states, they also have other uses in real estate.
Sometimes, a company (or person) may want to use a defeasance clause to put up a different asset as collateral in place of the property. In doing so, the defeasance clause will transfer ownership from the lender to the borrower, with the alternative asset (usually government securities like treasury bonds) standing in as collateral instead of the property.
Read the Fine Print
Every state subscribes to a mortgage theory that dictates whether the lender or borrower holds the title of the property. In title theory states, a defeasance clause takes effect when the mortgage is paid in full. The title is transferred from the lender to the borrower, nullifying the borrower’s obligation to the lender.
Do you know which mortgage theory applies in your state? Scroll up and review our list for a refresher or review your mortgage agreement and read the fine print.