By: John B. Newman, Retired

When a bank modifies a mortgage, whether a balloon, a work out or an accommodation, it must preserve the priority of its mortgage.  Typically, a first mortgage closing occurs after obtaining a full title search and a title insurance policy insuring the first mortgage position is issued.  Years may pass and then the mortgage is modified by changing the interest rate, the payments and the term and the new arrangement is evidenced by a mortgage modification agreement.  That agreement may or may not be recorded and the bank may or may not order a title search at that time.  Since junior mortgages or judgment liens may have attached to the mortgaged premises since the recording of the original mortgage, how can the bank be certain that the mortgage is still a first mortgage and that the other liens are subordinate to it?

The New Jersey Legislature addressed this issue by passing the Mortgage Priority Act.  It is important to understand the Act and its amendments because they affect all mortgage modifications.

First, the Act does not apply to construction loans.  On construction loans, the bank must secure a run down search at the time of each advance to insure that there are no other liens.  The priority of the mortgage loan will only extend to the amounts advanced before any other liens attach.

The Act provides that for all other mortgages, changes in the interest rate, due date or other terms and conditions do not affect the priority of the mortgage.  In addition, payments for taxes, assessments, insurance and other charges required pursuant to the terms of the mortgage are entitled to that priority.

The Act has a special provision for line of credit, such as many home equity mortgage.  For line of credit mortgages, advances of principal up to the maximum amounts stated in the line of credit are protected by the Act and retain their priority.  These mortgages can be paid down and additional advances ban be made from time tot time, with all advances retaining lien priority.

The Act specifically provides, however, that advances of principal on any mortgage other than a line of credit mortgage, do not have lien priority.  Thus, if a borrower has an amortizing mortgage with an original principal balance of $100,000 and pays the balance down to $70,000, the bank cannot advance $10,000 in additional principal and retain its mortgage priority as to that advance.  This means that in structuring work out arrangements, banks should be careful about capitalizing unpaid amounts and adding them to principal because that could potentially be considered an advance of principal and thereby lose its priority.  It is safer to provide for payment of the arrearage separately and for any other necessary modifications of the payment terms.

Finally, the Act provides unless a title insurance policy has a specific disclaimer which indicates that the policy will not continue to apply if the mortgage is modified pursuant to the Act, then the policy will remain in full force and effect after modification of the payment terms.  The Act also provides that the modification agreement need not be recorded.

Notwithstanding all of the protections provided in the Act, Newman & Simpson advises bank clients to always obtain a title search at the time of a modification to be sure that taxes are current, that there are no judgments against the borrower, that there are no unexpected secondary liens and that the borrower still owns the mortgaged premises!  The firm has defended a lender-liability case which arose after a modification which was executed without a title search where there were three years of unpaid taxes and over $1 million in judgment liens at the time of the modification.

This publication is intended for general information purposes only and does not constitute legal advice. The reader should consult legal counsel to determine how the law may apply to specific situations.