Many of us have borrowed money and used real estate as “collateral” for this loan of money. These provisions basically provide that if the borrower does not repay the money owed to the lender, the lender can sue the borrower and possibly force the sale of the building which would provide the money to repay the lender. In these situations, the “collateral” is the real estate pledged by the borrower to be sold if the borrower does not fully and on time repay the loan.
This process of having a loan in default that will be paid off by a collateral sold (an asset pledged to be sold if there is a default) is quite common in our economy. And the secured loan process is not particularly complex as long as a borrower only uses certain collateral for a single loan.
The law on the payment of several loans secured by the same collateral is not instinctive. A lender can lend a borrower $ 25 and be “secured” by a mortgage / lien on the borrower’s real estate. A second lender may come forward, believing the real estate to be worth $ 37, and lend the borrower an additional $ 12, with that $ 12 loan secured by a “second mortgage / lien” against the borrower’s real estate. The total indebtedness of the two loans guaranteed by the building is then $ 37.
The borrower may default on one or both of the loans, resulting in the sale of the property to pay off the loans. At the time of the sale, assume that the total amount owed to the two lenders together remains $ 37.
However, the property may have fallen in value since the second lender loaned the $ 12. So, if the sale of the property only brings in $ 30 in proceeds, the law specifies who gets paid first. In such a circumstance, the first lender would receive the full $ 25 owed to that lender. The second lender would receive the balance of the proceeds, $ 5, and would be forced to incur a loss of $ 7.
Many people assume that insufficient sales proceeds in the context of multiple lenders would be somehow prorated, with each lender suffering a proportional financial blow. However, the law applies a strict “first in time, first in law” principle when it comes to multiple mortgages / liens on the property. This principle allows lenders who are “first priority” to have confidence in their repayment resources, whether or not the borrower uses the same property as collateral for another loan.
However, many lenders prohibit granting “secondary” or “junior” mortgages to other lenders. This is because the more loans linked to a property, the more likely the borrower is to default, which would cause the first lender to receive the proceeds (even if the first lender is paid in full) and not collect. the interest income (benefits) that the first loan was originally designed to provide to the first lender.
Lee R. Schroeder is an Ohio Lawyer with Schroeder Law LLC in Putnam County. He limits his practice to business, real estate, estate planning, and agriculture in Northwestern Ohio. He can be reached at [email protected] or 419-659-2058. This article is not intended to serve as legal advice, and specific advice should be sought from the licensed lawyer of your choice based on the specific facts and circumstances you are facing.