Defeasance might not be a term you come across in your everyday conversations. However, when it comes to buying a home, understanding its significance is crucial. Defeasance refers to the termination or nullification of something, and in the context of mortgages, it is associated with a specific clause known as a defeasance clause. This clause has a significant impact on who holds legal ownership of your home: you or your lender.
Defeasance Clause: An In-Depth Look
If your home loan includes a defeasance clause, it essentially means that you do not have full ownership of the property until you have completely paid off your mortgage. Instead, the title is held by your mortgage lender. Thus, as long as you owe money on your mortgage, the lender technically retains ownership of the house.
Fortunately, this doesn’t mean your lender can suddenly take over and make themselves at home in your kitchen. The existence of the defeasance clause simply allows the lender to initiate foreclosure proceedings in court if you fail to make your mortgage payments. Foreclosure enables them to sell the house to recoup their losses.
However, once you have paid off your mortgage in full and satisfied all other loan requirements, the defeasance clause comes into effect. At this point, the title is transferred from the lender to you, making you the sole owner of the property, free and clear.
Understanding How Defeasance Clauses Operate
To determine whether your mortgage includes a defeasance clause, it’s crucial to review your mortgage documentation. The presence of this clause can vary depending on the state you reside in (see below for more details). If a defeasance clause is present, your lender will hold the property title until you have fully repaid your loan. Once your loan balance reaches zero, you will initiate the process of transferring the title to your name. This represents the moment of loan defeasance when you finally gain complete legal ownership of your property.
Different Types of Mortgage Theories
The inclusion or absence of a defeasance clause in your mortgage largely depends on the mortgage theory adhered to by your state. The three main theories are title theory, lien theory, and intermediate theory. Each theory determines the conditions under which a lender can assume ownership of a property if the borrower defaults on the loan.
Title Theory States: If you reside in a title theory state, your mortgage contract will invariably include a defeasance clause. Title theory empowers lenders to place the title of a home into a trust, using it as collateral until the borrower pays off the full loan amount. The following states adhere to title theory: Alaska, Arizona, California, Colorado, Georgia, Idaho, Mississippi, Missouri, Nebraska, Nevada, North Carolina, Oregon, South Dakota, Tennessee, Texas, Utah, Virginia, Washington, Washington, D.C., West Virginia, and Wyoming.
Lien Theory States: In contrast, lien theory states allow borrowers to retain the title to their property even while they still owe money on the mortgage. However, to clear their title from any encumbrances, borrowers must fully repay their mortgage. Lien theory states include Arkansas, Connecticut, Delaware, Florida, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, New Mexico, New York, North Dakota, Ohio, New Jersey, Pennsylvania, South Carolina, and Wisconsin.
Intermediate Theory States: Intermediate theory states offer a hybrid approach. In these states, the borrower initially holds the title to the property. However, a clause is triggered if mortgage payments are missed, ultimately reverting ownership back to the lender. Intermediate theory states consist of Alabama, Hawaii, Maryland, Massachusetts, Michigan, Minnesota, Montana, New Hampshire, Oklahoma, Rhode Island, and Vermont.
The Bottom Line
When you finally receive the keys to your new house, it’s important to recognize that full ownership isn’t immediate. If you financed your home purchase using a mortgage, your lender retains an ownership stake until the loan is completely paid off. The nature of this stake depends on your state and its chosen mortgage theory. If you reside in a title theory state, your mortgage likely includes a defeasance clause.
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