A defeasance clause is a provision in a mortgage agreement that grants the buyer title (the deed) to property after the terms of the loan have been fully satisfied.
Real estate transactions are extremely complex. For buyers, there are many different issues that need to be resolved — including getting financing for the property. According to data provided by the National Association of Realtors, approximately 75 percent of residential properties are bought with a mortgage. Real estate professionals should have an understanding of mortgages and related regulations.
In certain states, real estate buyers who purchase property with a mortgage loan need to be sure that there is a proper defeasance clause in their agreement. This contract provision will ensure that the title for the property is transferred free and clear to the buyer, once the mortgage is fully paid off and all of its terms are resolved.
Defeasance Clause: The Definition and Its Implications
In the most simple terms, a defeasance clause is a contract term included in a mortgage that will allow the homebuyer to redeem full, unencumbered rights to the property upon the last payment to the mortgage lender. In other words, the defeasance clause requires the lender to surrender all rights to the property once the mortgage is paid. The buyer gets title to the property.
With this understanding in mind, one might think that every buyer who has a mortgage should have a defeasance clause in their agreement. Not exactly. In reality, a defeasance clause should only be included in certain states. In certain jurisdictions, the real estate buyer will receive title to the property immediately — even if they still owe mortgage payments.
For buyers (and their representatives) who are in states that require defeasance clauses, it is crucial that they review the specific contract language contained in their agreement. The provisions are not always identical. For example, in some cases, a defeasance clause may be the place in the mortgage agreement that notes that the buyer would be subject to a prepayment penalty. Real estate buyers should always have a comprehensive understanding of their rights and responsibilities.
Study Tip: Defeasance Clauses are Not Necessary in Every State
Real estate laws vary across different the different jurisdictions. Currently, some states operate under title theory, wheres other states use the lien theory standard. In title theory states, the mortgage lender will hold the title to the property until they are repaid the full amount owed under the lending agreement. In these states, the mortgage paperwork should contain a defeasance clause. The defeasance clause is necessary to ensure that title to the property will transfer once the mortgage is settled. This is in contrast to lien theory states. In these jurisdictions, the mortgage lender never retains title to the property. Instead, the mortgage lender only has a lien against the property. While the ultimate economic effects are relatively similar regardless of the law, this is a difference that matters. The paperwork needs to be right — and it needs to conform to the appropriate state law. If there are errors, there could be major problems.
If you are studying for the real estate exam, it is imperative that you know the laws in your jurisdiction. Are you planning on taking the test in a title theory state or in a lien theory state? If you do not know the answer, you need to find out before test day. Real estate exams include both broad questions about real estate transactions generally — including economic, financial, and federal law questions that are applicable to every state — and they include state-specific questions. Make sure that you are studying the right materials.
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