When financing is involved in a real estate purchase, the buyer must understand if they will be subject to the title theory or lien theory of mortgages. States use either title theory or lien theory, which will determine how mortgage law is followed in that state.
A mortgage is a legal agreement where a bank or other creditor lends a borrower (debtor) money at interest to take the title of the borrower’s property. Mortgages are agreed upon the condition that the conveyance of the title become voids upon complete repayment of the debt.
Mortgages are designed for purchasing homes, allowing the buyer to break up their payments over a set number of years, paying an agreed amount of interest. Mortgages allow the home seller to claim the property if the buyer doesn’t make their payments and protects the buyer by prohibiting the seller from taking the property while payments are made. This way, mortgages protect both the seller and the buyer.
Title Theory vs. Lien Theory
Each theory has considerations on who will hold title and how foreclosure proceedings would occur if necessary.
In title theory states, the borrower does not keep the title to the property during the loan term. The seller gives the buyer a deed to the property, but when the borrower signs the mortgage for the loan, the borrower gives the title back to the mortgage holder (lender). This is done through a Deed of Trust and acts as a security for the lender. After the loan is completely paid off, the lender issues and records of Deed of Reconveyance, which removes any interests the lender may have in the property and gives the title back to the borrower.
In lien theory states, the deed stays with the borrower throughout the period of loan payments. The lender places a lien on the property using the mortgage. A lien is a right to keep possession of property belonging to another person until a debt owed is paid.
Foreclosures in Title Theory States vs. Lien Theory States
Foreclosure proceedings differ depending on the state in which you reside and whether it is a title theory state or lien theory state.
In title theory states, foreclosures require a judicial process. Judicial foreclosures are typically instigated after the lender files a foreclosure lawsuit, and the court issues a foreclosure judgment against the borrower. The property is then liquidated through a foreclosure auction by a designated representative or public official.
In lien theory states, foreclosure proceedings are non-judicial and handled by a trustee. These are often resolved quicker than judicial foreclosures. For non-judicial foreclosures to proceed, the original mortgage agreement should include the power-of-sale clause, granting the lender to proceed with a non-judicial foreclosure. If you’re a lender, it’s essential to make sure a power-of-sale clause is included in your mortgage agreement.
Intermediary Theory States
States that modified the title and lien theories are known as intermediary theory states. In intermediary states, the title remains with the borrower but with the expressed agreement that the lender may take back the title if the borrower defaults on the loan.
The intermediary states are:
- New Hampshire
- Rhode Island
Title Theory States
Twenty-seven U.S. states are title theory states. Seven states, marked with an asterisk are intermediary states.