What Is a Defeasance Clause and How Does It Work?

What Is a Defeasance Clause and How Does It Work?

A defeasance clause is a clause in a mortgage that states that the borrower's title to a mortgaged property is conditional on the borrower fully repaying the mortgage loan. A defeasance clause is commonly found in mortgage loan agreements in certain states. This clause states that you only get full ownership of your mortgaged property once your mortgage is paid off in full. The presence of a defeasance clause in your mortgage is determined by the state in which you live, but these clauses are based on a key question: When your mortgage loan closes, who owns the house: you or your lender? The answer may come in handy if you ever find yourself unable to make your mortgage payments and facing foreclosure.

Defeasance Clauses Definition and Examples

A defeasance clause states that the borrower's title to a mortgaged property is contingent on the borrower fully repaying the mortgage loan. Even though the homebuyer will have full use of the property for the duration of the loan, a defeasance clause gives the technical lender ownership of the home from the start of the loan. The term "defeasance" refers to declaring a contract condition null and void, and it's commonly used when making a series of payments, such as mortgage payments, and changing the contract's terms, such as transferring title from lender to borrower. States that follow a specific theory of ownership related to mortgage loans, known as title theory, are the most likely to have defeasance clauses. More than half of the states in the United States support title theory, so defeasance clauses are included in mortgage agreements. A mortgage loan agreement to purchase your primary residence in a title theory state is an example of how this could work. The document also included a clause stating that the lender retains title to your home until you have paid off your 30-year mortgage in full. If your circumstances change after a few years and you cannot make your payments to take possession of your home, your lender has the right to file a foreclosure lawsuit against you.

What is a Defeasance Clause, and How Does It Work?

Mortgage law uses defeasance clauses to determine who has full title to a property. In practice, new homeowners may feel like full owners of their homes because they are the people who make the decisions about how to modify the property and live there. In the event of nonpayment, lenders retain the legal right to take possession of the property and then sell it to recover their losses by foreclosing on it. The manner in which that procedure is carried out, on the other hand, is determined by the language used in the loan documents as well as the laws of the state. Suppose a borrower defaults on their mortgage before paying it off in full. In that case, defeasance clauses allow a lender to use judicial foreclosure through the courts in states that follow the title theory. While laws change, the following states are generally considered title theory states, which means you can expect a defeasance clause in your mortgage contract:
  • Alaska
  • Arizona
  • California
  • Colorado
  • Washington, D.C.
  • Georgia
  • Idaho
  • Mississippi
  • Missouri
  • Nebraska
  • Nevada
  • North Carolina 
  • Oregon
  • South Dakota 
  • Tennessee
  • Texas
  • Utah
  • Virginia
  • Washington 
  • West Virginia 
  • Wyoming

Defeasance Clause Alternatives

Alternatively, a state may follow the lien theory, in which the title to the property passes to the borrower when the transaction is completed. The lender has a lien on the property that they can use to foreclose on if necessary. In such cases, a trustee will handle foreclosure proceedings rather than the courts in a lien theory state. The other option, known as the intermediate theory, is a kind of middle ground. The borrower retains ownership of the property but surrenders it to the lender if the loan is defaulted on. Note that assuming ownership of a home in a lien theory state is generally more difficult than in a title theory state. Under all three types of mortgage law, borrowers can act as property owners; the lender is unable to make decisions about the property unless the borrower defaults on their payments. If the borrower defaults, however, the process in each state will differ depending on whether a judicial or nonjudicial foreclosure is required. Even with the three types of theories, the paperwork of how ownership is transferred may differ slightly, with documents bearing slightly different names, so talk to your lender about how your title will transfer based on the contract you signed.

Important Points to Remember

  • A defeasance clause is a clause in your mortgage agreement that is only present in states that follow "title theory," which is a method of recognizing ownership.
  • The title theory and the lien theory are two approaches to determining who owns the property under the terms of a mortgage loan.
  • Only when you pay off the mortgage loan in full does the defeasance clause give the homeowner (rather than the lender) full title. Until then, if the borrower defaults on the loan, the lender can use judicial foreclosure to take possession of the property and sell it to recover loan losses.

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