When purchasing a foreclosure or bank-owned property from Auction.com, you should verify if the property is subject to the title or lien theory of mortgages, depending on whether it is situated in a lien state or a title state. Each theory provides directives on who will hold title and how foreclosure proceedings will take place. But before we jump into the two theories, let’s discuss how a mortgage works.
The terms of the mortgage which define the payment schedule, will also typically include an acceleration clause that spells out conditions under which the mortgagee can declare that the entire mortgage balance is due and demandable. Nonpayment of monthly balances over a given period usually triggers the start of the foreclosure process, which will empower the lender to pursue full repayment of the mortgage loan. The foreclosure process varies from state to state, depending on the specific set of guidelines for mortgages that apply in each state.
Now we are ready to explore the differences between lien theory and title theory in real estate.
Lien Theory States
In a lien state, the buyer, who is also the borrower, will hold the deed to the real estate property for the duration of the mortgage payments. During this period, the buyer has both legal and equitable title giving them the right to sell or transfer the property if the mortgage is eventually paid off, according to the terms spelled out in the financing agreement. The mortgage agreement serves as the lender’s lien, or security interest, on the property until the loan is paid back completely, but the buyer holds the title to the property instead of the lender. The lien is eliminated when the loan is paid off in full.
These are the states where mortgage laws are defined by lien theory:
- Arkansas
- Connecticut
- Delaware
- Florida
- Hawaii*
- Illinois
- Indiana
- Iowa
- Kansas
- Kentucky
- Louisiana
- Maine
- Maryland*
- New Mexico
- New York
- North Dakota
- Ohio
- Oklahoma*
- New Jersey
- Pennsylvania
- Puerto Rico
- Rhode Island*
- South Carolina
- Vermont*
- Wisconsin
Title Theory States
In a title theory jurisdiction, the lender retains legal title to the property as security for the loan. The borrower has equitable title, which gives them the right to occupy and use the property, and also, obligates them to pay related expenses, such as property taxes. However, the lender’s legal title means they technically own the property until the mortgage is paid off.
These are the title theory states:
- Alabama*
- Alaska
- Arizona
- California**
- Colorado
- District of Columbia
- Georgia
- Idaho
- Massachusetts*
- Michigan*
- Minnesota*
- Mississippi
- Missouri
- Montana*
- Nebraska
- Nevada
- New Hampshire*
- North Carolina
- Oregon
- South Dakota
- Tennessee
- Texas
- Utah**
- Virginia
- Washington State
- West Virginia
- Wyoming
Intermediary Theory
A modified version of title and lien theories may also be used as the basis of evaluating mortgage laws. In intermediary theory states, the borrower retains legal title, while the lender retains equitable title, meaning there is typically an agreement that the lender’s interest automatically converts from a lien into legal title if and when the borrower defaults on their loan. Accordingly, the lender can typically take back possession of the property without need for judicial foreclosure proceedings.
*States with an asterisk in both lists provided above are intermediary states.
**Another caveat comes with Section 5 of the California Department of Estate’s reference book which considers California a ‘lien’ and not a ‘legal title’ theory state as per a settled law. However, the decision on the title theory for the state remains in a ‘debated’ status. Similarly, Utah’s status as a title theory state is also subject to debate as legal cases pertaining to this have come to differing conclusions.
Differences in Foreclosure Proceedings
Interpretation of mortgage laws depends on whether the state is classified as a lien or title theory jurisdiction. In most cases, mortgage agreements will include due-on-sale or due-on-encumbrance clauses to prevent the transfer of mortgages to a party other than the buyer involved in the original financing contract.
These escalation clauses are triggered by certain events such as the sale of the property or borrower’s failure to comply with the payment schedule. In states that subscribe to title theories where property ownership is held by the lender, foreclosures will require a judicial process. Generally, a judicial foreclosure is instigated after the lender files a foreclosure lawsuit and the court issues a foreclosure judgment against the borrower. The security property is liquidated through a foreclosure auction handled by a public official or a designated representative, such as Auction.com. Before the internet, foreclosure auctions were only held on the courthouse steps with the sheriff taking a lead role in managing the auction. These auctions were also referred to as sheriff’s sales.
Foreclosure proceedings in lien theory states are managed by a trustee. The non-judicial process is often resolved sooner than judicial foreclosures. Most non-judicial foreclosures are handled without any interaction with the courts. However, it is important to note that the original mortgage agreement should include the power-of-sale clause, which grants the lender the right to proceed with a non-judicial foreclosure.
Auction Sales
Regardless of which set of mortgage laws apply in your state, a comprehensive resource of auction listings is a useful reference as you build up your real estate investment portfolio. Browse the Auction.com website to determine if any of the current listings meet your investment portfolio targets.
Sources:
Mortgage
LII Staff – https://www.law.cornell.edu/wex/mortgage
The Difference Between a Title Theory and a Lien Theory State
Nelly Korbut – https://activerain.com/blogsview/311645/the-difference-between-a-title-theory-and-a-lien-theory-state
United States Map Of Title Theory States and Lien Theory States; What’s the Difference Between a Title and a Lien State?
What Is The Difference Between a Title Theory and a Lien Theory State?
https://sandygadow.com/what-is-the-difference-between-a-title-theory-and-a-lien-theory-state/
