Which clause is used to give title back to the borrower when the loan is paid in full under a defeasance arrangement?

In certain states, it is common for a mortgage loan agreement to include a defeasance clause. This clause states that full title to your mortgaged property transfers to you only after your mortgage is paid in full. 

Whether you’ll encounter a defeasance clause in your mortgage depends on the state you live in, but these clauses are rooted in a key question: Who owns the home at the time your mortgage loan closes: you or your lender? The answer can be very relevant if you ever find yourself unable to make your mortgage payments and facing foreclosure.

Definition and Examples of Defeasance Clauses

A defeasance clause states that the title to a mortgaged property in the loan agreement is dependent on the borrower paying off the mortgage loan completely. A defeasance clause gives the lender technical ownership of the home starting at the beginning of the loan even though the homebuyer will have full use of the property during the loan’s duration.

The word “defeasance” refers to declaring a contract condition null and void, and it is often used when completing a set of payments, such as mortgage payments, changes the conditions of the contract, including transferring a title from lender to borrower.

The states where defeasance clauses are common are those that follow a particular theory of ownership related to mortgage loans, called title theory. More than half the states within the U.S. support title theory and therefore have defeasance clauses in their mortgage agreements.

An example of how this might work would be if you signed a mortgage loan agreement to purchase your primary residence in a title theory state. Included in the document was a provision stating that the lender holds the title to your property until you complete all payments on the 30-year mortgage. If you get a few years into your mortgage and have a change in circumstances that means you cannot make your payments, the lender has the right to file a foreclosure lawsuit in the court system against you in an attempt to take possession of the home. 

How a Defeasance Clause Works

Defeasance clauses are a part of how mortgage law determines who has full title to a property. In practice, new homeowners may feel like the full owners of their homes in the sense that they make the decisions about modifying the property and are the ones who live there. However, lenders technically retain the ability to take possession of the home and sell it to recoup their losses through foreclosure in instances of nonpayment.

The way in which that procedure occurs, however, is dependent on the actual language in the loan documentation and the laws of that state. In states that subscribe to title theory in their laws, defeasance clauses pave the way for a lender to use judicial foreclosure through the courts if a borrower defaults on their mortgage before paying it off in full.

While laws can change, the following states are generally considered title theory states, so you can expect to see a defeasance clause in mortgage contracts there:

• Alaska
• Arizona
• California
• Colorado
• Washington, D.C.
• Georgia
• Idaho
• Mississippi
• Missouri
• Nebraska
• Nevada
• North Carolina
• Oregon
• South Dakota
• Tennessee
• Texas
• Utah
• Virginia
• Washington State
• West Virginia
• Wyoming

Alternatives to Defeasance Clauses

Alternatively, a state may follow a lien theory, in which the title passes to the borrower when the purchase occurs. The lender maintains a lien on the property, with which they could foreclose on if necessary. In such cases, foreclosure proceedings in a lien theory state will go through a trustee instead of the courts.

The other alternative, intermediate theory, functions as a sort of middle-road, in which the borrower holds the title but defaulting on the loan reverts that title back to the lender.

Note

It is generally more challenging for a lender to assume ownership of a home in a lien theory state than in a title theory state.

In all three types of mortgage law, borrowers can function as owners of the property; the lender cannot make decisions about the property unless the borrower stops making their scheduled payments. However, if the borrower defaults, the process in each kind of state will differ depending on whether a judicial or nonjudicial foreclosure will have to occur.

Even within the three types of theories, the documentation of how ownership is transferred may vary slightly, with documents having subtly different names, so it’s important you talk to your lender about how you can expect your title to transfer based on the contract put in place. 

Key Takeaways

• A defeasance clause is a section of your mortgage agreement that is only present in a state that subscribes to “title theory,” a way of recognizing ownership.
• Title theory and lien theory are two ways of acknowledging who owns a property under a mortgage loan.
• The defeasance clause gives full title to the homeowner (rather than the lender) only when the mortgage loan is paid off in full. Until then, the lender can use a judicial foreclosure if the borrower defaults on the loan, taking possession of the property and selling it to recoup losses on the loan. 

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