Definition:
Defeasance is a legal provision that allows borrowers to regain the ownership of their property after a default on the mortgage, typically by paying their remaining debt, along with any additional fees and penalties incurred. This clause is designed to offer borrowers a second chance to rectify their financial obligations before the lender takes full possession of the property due to the default.
Examples:
- Residential Example: John fails to meet his mortgage payments due to unforeseen financial difficulties. Once he manages to gather the required amount by liquidating other assets, he clears all his outstanding dues. The defeasance clause in his mortgage allows him to reclaim his house despite his initial default.
- Commercial Example: Company XYZ defaults on a loan for their office building. The company then secures alternative financing to pay off the defaulted loan entirely. The defeasance clause enables them to obtain clear title to the property instead of facing foreclosure.
Frequently Asked Questions:
What is the purpose of a defeasance clause in a mortgage?
The purpose of a defeasance clause is to provide borrowers an opportunity to recover ownership of their property after a default by repaying all outstanding debts and associated fees.
How does a defeasance clause work?
Upon default, if a mortgage contains a defeasance clause, the borrower can redeem their property by paying off the remaining balance of the loan and any related costs. This clause essentially overrides the lender’s right to take possession of the property immediately upon default.
Are defeasance clauses common in all types of mortgages?
Defeasance clauses are more commonly seen in commercial mortgages but can also be included in residential mortgages. Their prevalence largely depends on the lender’s policies and the terms agreed upon at the time of signing the mortgage.
What is the difference between defeasance and prepayment risk?
Defeasance aims to protect the borrower by allowing redemption after default, while prepayment risk pertains to the lender’s concern that the borrower repays the loan earlier than anticipated, potentially affecting investment returns.
Can defeasance clauses be negotiated at the time of mortgage origination?
Yes, borrowers can negotiate the inclusion or specific terms of a defeasance clause when finalizing their mortgage agreements, making it crucial to thoroughly review and understand all conditions.
- Prepayment Clause: A clause that allows the borrower to pay off a mortgage before its official end date.
- Acceleration Clause: A clause in a mortgage that allows the lender to require the borrower to repay all of an outstanding loan if certain conditions, such as default, are met.
- Balloon Payment: A large payment due at the end of a balloon loan, often part of mortgages with smaller monthly payments followed by a significant final payment.
Online Resources:
References:
- “Mortgage Defeasance for Commercial Real Estate Transactions”, John Wiley & Sons.
- “Real Estate Investment Trusts: Structure, Analysis, and Strategy,” by Richard Garrigan and John Parsons.
Suggested Books for Further Studies:
- “Real Estate Finance & Investments” by William Brueggeman and Jeffrey Fisher.
- “Commercial Mortgage-Backed Securities” by Frank J. Fabozzi.
- “The Real Estate Finance and Investment Manual” by Jack Cummings.
Real Estate Basics: Defeasance Fundamentals Quiz
### What is the primary function of a defeasance clause in a mortgage?
- [ ] To allow the lender to immediately seize the property upon default.
- [ ] To provide the borrower with a lower interest rate.
- [x] To enable the borrower to regain ownership of the property after default.
- [ ] To eliminate all borrower obligations upon loan initiation.
> **Explanation:** The defeasance clause grants the borrower the right to regain ownership by paying off the debt and incurred fees after a default.
### When can a borrower utilize the defeasance clause?
- [ ] Immediately after taking out the loan.
- [x] After defaulting on their mortgage payment.
- [ ] When requesting a lower interest rate.
- [ ] Before signing the mortgage agreement.
> **Explanation:** A borrower can utilize the defeasance clause specifically after defaulting on their mortgage.
### Which of the following must a borrower typically pay to exercise a defeasance clause?
- [ ] Only a portion of the remaining loan balance.
- [x] The full remaining mortgage balance and additional costs.
- [ ] Prepayment fees only.
- [ ] Nothing; it is fee-free to exercise.
> **Explanation:** To exercise a defeasance clause, the borrower must pay off the full remaining loan balance along with any additional fees incurred.
### Defeasance clauses are introduced to protect whom?
- [ ] The real estate broker.
- [ ] The mortgage underwriter.
- [ ] The property's selling agent.
- [x] The borrower.
> **Explanation:** Defeasance clauses are introduced to protect the borrower's ability to recover the property after a default.
### A defeasance clause is most likely to be found in which type of loan?
- [ ] Personal loan
- [ ] Credit card agreement
- [ ] Car lease agreement
- [x] Mortgage loan
> **Explanation:** Defeasance clauses are most commonly found in mortgage loans.
### What differentiates defeasance from a prepayment clause?
- [ ] Both allow early repayment without penalties.
- [ ] Defeasance applies before the loan starts.
- [x] Defeasance is used post-default, while a prepayment clause involves early payment before the end term.
- [ ] There is no difference.
> **Explanation:** Defeasance deals with loan redemption after default, while a prepayment clause involves early payment before loan term ends.
### In real estate terms, what specifically can borrowers reclaim under a defeasance clause?
- [x] Ownership rights to the property.
- [ ] All paid mortgage interest.
- [ ] Monthly mortgage discounts.
- [ ] Scheduled maintenance careers.
> **Explanation:** Under a defeasance clause, borrowers can reclaim ownership rights to the property after default.
### Which party mainly benefits from a defeasance clause?
- [ ] The property buyer.
- [ ] The mortgage lender.
- [x] The borrower.
- [ ] The property inspector.
> **Explanation:** The borrower is the party that primarily benefits from a defeasance clause.
### At what point is a defeasance clause typically activated?
- [x] After a borrower's default.
- [ ] During property appraisal.
- [ ] When a down payment is made.
- [ ] Upon the first mortgage payment.
> **Explanation:** A defeasance clause is typically activated after a borrower defaults.
### What is a common requirement for a borrower to fulfill a defeasance clause?
- [ ] Obtain a construction permit.
- [ ] Submit weekly payment.
- [x] Pay complete loan balance and incurred fees.
- [ ] Land survey documentation.
> **Explanation:** A borrower must pay the entire loan balance and additional fees to fulfill a defeasance clause.
