A defeasance clause is the part of your mortgage contract that ensures you’ll receive the title to your home when you repay your mortgage loan. But these are only used in certain states.
When you buy a home for the first time, you’re likely to come across all sorts of terminology that you’ve never heard before, and it’s easy to feel overwhelmed. This scenario is especially true when it comes to the mortgage contract. And when you see a term like “defeasance clause” as you’re signing papers on the closing day, it’s natural to wonder how it could affect you.
Don’t worry — a defeasance clause is actually a good thing. It ensures that when you’ve met your obligation of repaying your mortgage loan, you’ll receive the title for your home. Keep reading to learn more about how defeasance clauses work and where you can expect to encounter one.
What is a defeasance clause?
A defeasance clause is a part of a mortgage contract that states that when the borrower has fully paid off the loan, they’ll receive the title for the property. This clause stems from the word defeasance, which is “the process of rendering a condition in a deed or contract null and void.” Essentially, it means that once you repay your loan, your mortgage lender no longer has a claim to your home, which results in loan defeasance.
A defeasance clause is there to protect you as the buyer since it ensures that once you’ve kept your end of the bargain and made your mortgage payments, you’ll get full ownership and control of the home. However, not all mortgage agreements include these clauses. As we’ll discuss in detail below, defeasance clauses only appear in states that use title theory for mortgage law.
How does a defeasance clause work?
Most people can’t afford to buy their homes in cash, meaning they must rely on a mortgage from a lender. And when a financial institution lends such a large amount of money, it wants some reassurance that it will get its money back. To that end, lenders generally require collateral.
Collateral refers to a physical object that secures a loan. If the borrower stops making their monthly payments, the lender has the right to seize the property. When you take out a secured mortgage, the property you’re buying serves as collateral for the loan. So if you stop making your payments, you’ll go through a process called foreclosure.
Exactly how foreclosure proceedings work depends on which state you live in and whether it’s a lien property or title property state. These concepts are covered in more detail below, but for now, know that states that follow title theory use defeasance clauses. As long as you still have a balance on your mortgage loan, your lender holds your property’s title in case you default on it. But once you’ve fully repaid the loan, the defeasance clause stipulates that you receive the title to the property.
As mentioned above, defeasance clauses don’t exist everywhere. Right now, nearly half of states use them in their mortgage agreements. Your mortgage may include a defeasance clause if you live in one of the following states:
|District of Columbia||North Carolina||Washington|
Title theory state vs. lien theory state
The previous section mentioned the concept of title theory and how it affects mortgage agreements. In a title theory state, the lender holds the title to the property until the borrower has fully paid off the mortgage loan. So while you may be living in the home, it technically belongs to the bank that lent you the money for it.
In states that subscribe to title theory, mortgage agreements include a defeasance clause. It requires that the lender release the title to the property to you when you pay off the loan.
States that don’t use title theory typically use lien theory, which means that the borrower holds the real estate title. Rather than holding the property title, the mortgage lender simply places a lien on it. This lien gives them the right to foreclose on the home if the borrower defaults on the loan. But as long as the borrower is up-to-date on their mortgage payments, the lender will give them an equitable title, which is the right to possess and live in the home. This is not the same as full ownership of the home.
In lien theory states, there is no defeasance clause. Instead, when you fully repay your mortgage, the lender’s lien is released from the title to the property and you take full ownership of the home.
There are some states that practice a combination of title theory and lien theory. The borrower maintains the property title, but if they default on the loan, the mortgage agreement gives the lender the right to take the title back. These are known as intermediary theory states, and they include the following:
When does a defeasance clause apply?
A defeasance clause is used in mortgage agreements in states that subscribe to title theory for their real estate laws.
Who does a defeasance clause protect?
The defeasance clause protects you as the real estate buyer, since it ensures you’ll receive the title to your property when you repay your mortgage.
When would the defeasance clause in a mortgage take effect?
The defeasance clause in a mortgage takes effect when the borrower has repaid their mortgage in full.
What is an assumption clause?
An assumption clause also appears in mortgage agreements. It gives a borrower the right to pass their mortgage responsibility along to a new home buyer. This is also known as an assumable mortgage. When a new buyer assumes the mortgage and pays it off, they receive the home’s title under the defeasance clause.
- A defeasance clause in a mortgage states that once the loan has been repaid, the title to the property will be transferred from the lender to the borrower.
- A defeasance clause protects both the mortgage lender and the borrower. It allows the lender to hold the title until they get their money back but ensures the borrower will receive it when they’ve held up their end of the bargain.
- Defeasance clauses aren’t used in all states, only those that use title theory in their real estate laws, meaning the mortgage lender holds the title until the loan is repaid.
- In lien theory states, rather than holding the title, the mortgage lender places a lien on the property. Because of this, no defeasance clause is involved.
A defeasance clause may appear in your mortgage if you live in a title theory state. While it might sound intimidating, it’s actually good for borrowers. It ensures that once you pay off your mortgage, you’ll receive the title to your property.
Are you in the market for a new home? We can help! We’ve rounded up a list of the top mortgage lenders to help you choose the best one for your next home purchase. Try our comparison tool to read customer reviews and learn about the various features each lender offers.
View Article Sources
- Defeasance – Legal Information Institute, Cornell Law School
- Mortgage – Legal Information Institute, Cornell Law School
- Title Theory States 2022 – World Population Review