7.1 Financing Concepts, Notes, Mortgages, and Deeds of Trust

The Two Documents in Every Financed Sale

When a buyer borrows to purchase property, two separate documents are created. The promissory note is the borrower's written promise to repay the debt; it states the amount, interest rate, payment schedule, and maturity date. The security instrument pledges the property as collateral so the lender can foreclose if the borrower defaults.

A classic exam trap: the note is the debt, while the mortgage or deed of trust merely secures the debt. If you pay off the note but the lien is never released, the obligation is gone even though the public record still shows a lien.

Mortgage vs. Deed of Trust

A mortgage has two parties: the mortgagor (borrower, who gives the mortgage) and the mortgagee (lender, who receives it). Default usually leads to judicial foreclosure through a court.

A deed of trust (or trust deed) has three parties: the trustor (borrower), the beneficiary (lender), and a neutral trustee who holds bare legal title. On default, the trustee can use the power-of-sale clause for faster non-judicial foreclosure without a lawsuit.

Hypothecation and Title Theory

Hypothecation is pledging property as security for a debt while keeping possession and use of it. The borrower lives in the home throughout the loan term despite the lien.

States follow one of three theories. In a lien-theory state, the borrower holds title and the lender holds only a lien. In a title-theory state, the lender (or trustee) holds legal title until the loan is paid. Intermediate-theory states blend the two: the borrower holds title until default. The theory affects how quickly a lender can take possession and which foreclosure path applies.

Essential Loan Clauses

• Acceleration clause: Lets the lender demand the entire balance immediately upon default. Without it, the lender could only sue for missed payments.
• Alienation (due-on-sale) clause: Requires full payoff if the property is sold or transferred, blocking an unauthorized loan assumption.
• Defeasance clause: Requires the lender to release the lien once the debt is fully paid, triggering a satisfaction or reconveyance.
• Prepayment clause/penalty: Permits early payoff; a penalty may charge a fee for paying ahead of schedule.
• Subordination clause: A lienholder agrees to let a later loan take priority — common with construction financing.

When the loan is satisfied, a mortgage lender records a satisfaction of mortgage, while a deed-of-trust beneficiary directs the trustee to record a deed of reconveyance.

Default, Foreclosure, and Borrower Protections

When a borrower stops paying, the lender's path depends on the instrument and on state law. Wisconsin is a mortgage (lien-theory) state that uses judicial foreclosure through the circuit court, so a salesperson should expect mortgage terminology, not power-of-sale trustee language, on the state portion.

Two rights of redemption are tested:

• Equitable right of redemption — before the foreclosure sale, the borrower may reinstate by paying the full balance plus costs.
• Statutory right of redemption — some states give a window to redeem after the sale; Wisconsin instead uses a pre-sale redemption period (commonly six months, or shorter when the lender waives a deficiency judgment).

Exam trap: a deficiency judgment lets the lender pursue the borrower personally for the shortfall when the sale brings less than the debt. A lender that waives the deficiency often gets a shortened redemption period in return.

Alternatives to Foreclosure and Senior-Lien Order

Foreclosure is slow and costly, so the exam tests three softer exits:

Lien priority decides who is paid first from the foreclosure proceeds. The general rule is first to record, first in right, with one major exception: property-tax and special-assessment liens jump ahead of every private lien, including a first mortgage. So at a foreclosure sale the order is typically: unpaid real-estate taxes, then the first mortgage, then junior mortgages and judgment liens by recording date.

Worked scenario. A home sells at foreclosure for $240,000. Outstanding items are $6,000 in delinquent property taxes, a $200,000 first mortgage, and a $60,000 second mortgage. The taxes are paid first ($6,000), then the first mortgage ($200,000), leaving $34,000 toward the $60,000 second — the second lender absorbs a $26,000 loss and the first mortgage is fully satisfied. Memorizing that taxes come off the top is one of the most reliable points in this section.

Lien-position trap: a deed in lieu of foreclosure does not erase junior liens — the lender takes the property still burdened by them, which is exactly why lenders often prefer a foreclosure sale (which can wipe out properly noticed junior liens) over accepting a deed in lieu when other liens exist.