Your real estate exam will be tricky, and the laws around buying property can sometimes be confusing. Several terms and provisions in contracts need to be met, some of which include a defeasance clause.
A defeasance clause is a term in a real estate contract and is founded on the notion of defeasance.
Defeasance is a process of law that renders something null and void. This clause is essential in certain real estate contracts to ensure that a buyer guarantees their property title.
What Is a Defeasance Clause?
Simply put, a defeasance clause is a provision in a mortgage contract that allows the buyer to gain the full right to the property upon the final payment to the mortgage lender.
It becomes effective when a mortgage is paid off in full.
Once the borrower has reached the end of their mortgage loan, the title is fully transferred from the lender to the borrower.
The defeasance clause can be used to summarize the last procedures in a mortgage loan contract where real estate property is used as collateral, such as in buying a house or a building.
Secured mortgage loan contracts will always have detailed procedures on managing property rights throughout the mortgage loan and, if needed, its defeasance.
Is Defeasance Clause Always Required?
Although it seems to be a crucial requirement, defeasance clauses are not always necessary. In some states, the real estate buyer immediately receives the title to the property, even if they have existing mortgage payments or debt.
For states that do require defeasance clauses, it’s critical that the buyer properly reviews the contract language when the lender states the mortgage agreement to ensure that the provision is met.
Often the defeasance clause will look different to one in another contract. Having competent representation and knowing their rights and responsibilities will help the buyer navigate the contract clauses.
Different Real Estate Laws: How Is Defeasance Clause Related?
Every state has its own set of real estate laws. Some states use lien theory, while others use title theory. Depending on which theory your state follows, a defeasance clause may or may not be a requirement.
In lien theory states, the borrower holds the deed, all rights reserved, to the real estate property for the duration of the mortgage.
The borrower agrees to pay the mortgage according to the terms established in the financing agreement, which serves as the lender’s lien while the borrower pays off the loan.
Still, the borrower holds the title to the property. When the loan has been paid in full, the lien is extinguished.
Title Theory State
In title theory states, the bank or the mortgage lender holds the title to the property, all rights reserved, until the loan is paid in full.
The right to the real estate property then goes to the borrower when the title has been delivered after the loan has been fulfilled.
In these states, the defeasance clause is necessary to ensure that the title is transferred to the borrower once the mortgage loan is paid off.
Although economically, the result is similar, it is important to note the differences in state laws and how it affects drawing up contracts.
The terms of each mortgage contract must be clearly stated and well understood by all parties involved.
There are, however, some special considerations wherein a defeasance clause can mean transferring alternative collateral. This type of defeasance clause allows the borrower to gain title to the property before the mortgage is paid off by exchanging alternative collateral, such as other investment assets, for the secured real estate property collateral.
Understanding Property Laws
If you’re buying any form of real estate or studying for the real estate exam to be a real estate broker, it is pertinent that you understand the importance of a defeasance clause.
Comprehending state law and knowing which states require the defeasance clause is the responsibility of the buyer.
If the mortgage lender and property borrower are both aware of the state laws, establishing a mortgage loan and agreement will be clear-cut and straightforward.
Agreeing on the conditions of the defeasance clause will smooth out the process of buying real estate.
On the other hand, if you are taking or studying for a real estate exam, it is best to determine which real estate theory your state follows.
Depending on the state, the real estate exam will include both broad questions on property payment and transactions that apply to all states as well as state-specific questions.
Is the state a lien or a title theory state? This means knowing information, such as if the state requires a defeasance clause as a mortgage provision.
Every broker should know their local state’s requirements on real estate title and property sale.