Sub 2 Deal in a Title Theory State.

[Rich Hupper]

Hi Biggerpockets

I am trying to better understand the concept of title and the bundle of rights that come with real property.

Lets say we have a sub 2 deal in a title theory state. The owner of the property is highly motivated to sell, tired of dealing with his tenants, heading to foreclosure and looking for debt relief. You offer to start paying his debt and bring his loan current in exchange for a deed. 

Please excuse me if I am wrong here, however in a title theory state the mortgagee / lender holds legal title on that deed and the borrow / current owner holds equitable title on the deed. I am trying to figure out when a sub 2 deal is executed, is the equitable title of the Mortgagor/borrower transferred to the sub 2 buyer? And legal title stays with the mortgagee? If this is true.....

I thought equitable and legal title are one in the same whole,  shared between the mortgagor and mortgagee.

Also in a sub 2 deal a buyer pays a homeowners payments in exchange for a deed, however does that deed convey all the rights and covenants of a warranty or special warranty deed? What kind of deed is used in this transaction? Just how many rights and covenants can an owner who has a mortgage on his property convey to a new buyer without first settling the debt he has with the mortgagee?

It seems the Sub 2 buyer is acquiring a heavily clouded title that has limited rights because most of them are tied up mortgage contract between the mortgagor and mortgagee. 

In crafting a purchase and sale agreement for one of these deals, there must be very specific language to address how title is being conveyed. Can anyone elaborate on this?

Thank you

[Brian Gibbons]

Hi @Rich Hupper

When you receive legal title, you own it.

It is encumbered by a lien that is not your debt.

Sub2 is good for fix and flips, not for buy and hold long term.

You are thinking too much. :)

@Bill Gulley

[Bill Gulley]

Rich, You're right that in a title theory state, the lender has legal title, but that is conditioned upon a released upon payment of the debt, might think of it as the homeowner being in second position. They both have an equitable interest as well, but the homeowner clears the financial interest held by a lender as the debt is paid. The homeowner also has the right to convey any and all interests, paying the debt in full. 

In a sub-to, the owner conveys their "second position" in legal title and all of their equitable title, according to the degree of conveyances as contracted (all or part of their title interests).

A Special Warranty Deed is the same as a General Warranty Deed except the SWD describes aspects of title that are not warranted, for example, all rights except those interests held by XYZ Bank.    

Rich conveys marketable title to Bill, "except and subject to the lien interest in favor of XYZ Bank, shown in the Office of the Recorder of Deed public of Tin Cup County, RC, in Book 123, at Page 321".

For a contract, "title taken by buyer subject to the existing mortgage having an approximate balance of $33,333.33 in favor of XYZ Bank" .....usually acceptable unless state law dictates specific language.  

   The issue is not that title rights are clouded, as the seller conveyed those rights, the issue is the due on sale clause in the mortgage, the bank can call the loan due. Simply (LOL) pay it off and all rights revert to you.

Looks like you're studying! Great!! :)

[Brian Gibbons]

Thank you @Bill Gulley

[Rich Hupper]

@Brian Gibbons

@Bill Gulley

Thank you both for commenting. 

Bill to elaborate further in a title theory state, trust deeds are used instead of mortgages however everyone calls them mortgages? The mortgagor as a legal interest as the trustee and the equitable interest as the beneficiary. 

If this is the case let me get this straight. 

At closing the grantor deeds his title in the real estate into a trust where a grantee becomes a mortgagor/trustee/beneficiary of the said trust deed. This new owner has 100% legal and equitable interest in this real estate being conveyed at this time. 

However there is a condition ( failure to pay the loan/transfer of title ) in this trust, where once met, the mortgagor loses his 100% equitable and legal interest to the mortgagee. The mortgagee then becomes a first position trustee and  beneficiary pushing the mortgagor into second position. This gives the mortgagee the ability to foreclose/accelerate the loan, and a stake in the equitable and legal interests.

Upon bringing the loan current, the mortgagee disappears into that conditional state and the mortgagor is once again a first position trustee and the only beneficiary 

OR....

Upon closing the mortgagee immediately holds 51% legal interest in the real estate conveyed as a first position trustee and 0% equitable / beneficiary interest. The mortgagee has a future conditional beneficial interest in the real estate if and when the mortgagor breaches the contract. 

The mortgagor holds 49% legal interest as a second position trustee and 100% equitable interest as the only beneficiary. 

If the mortgagor breaches the contract then the mortgagee becomes a beneficiary of the trust sharing the equitable interests with the owner 50/50.

I know I have a lot to learn about all this however I like to understand the nuts and bolts before I go knocking on doors.

[Bill Gulley]

@Rich Hupper

What I suggested above was to simply convey a concept of shared title interests, it's not really a first-second position but shared, sorry to confuse you, it was the short version to illustrate 2 parties having legal rights in title. "Mortgage" actually means pledge. All notes secured by real estate are a mortgage, real estate is pledged as collateral. A mortgage is a loan secured by real estate under two theories at law, being secured as a lien or by taking title allowing the borrower/owner to benefit hold title subject to a lien and enjoy the bundle of rights. A mortgage in title theory sets title in a Trustee under the deed of trust, this still provides the owner/borrower with rights to benefit from the bundle of ownership rights.

Lien theory states; A lender is in a lien position, the borrower grants a specific lien, the borrower takes title subject to the lien, this is accomplished with a deed of trust. The bundle of rights are taken subject to the lien held by the lender. Before title is conveyed by that owner, the lender will insist their lien be paid off, this is part of the foundation of the due on sale clause. Review the Basics Course as to types of Specific Liens that encumber title. 

Title theory states;  A buyer conveys legal title to a third party trustee who holds title in trust. This trust agreement or deed of trust only allows legal title to be conveyed to the lender/beneficiary and only in the default of the borrower. The trustee has no other interest in the legal title, such as possession, power of sale, rights to benefit from that title interest so long as the borrower meets the agreements of the note and terms of the mortgage. It is AS IF a borrower were to hold a primary or secondary interest with a lender being a primary or secondary holder, not really who is on first, but shared and only to the extent of the terms of the security agreement.    

There is no percentage of legal title being held under either theory. If a borrower defaults under a mortgage in title theory, the lender calls the obligation due and if not paid, conveys full title to the lender under foreclosure proceedings. In lien theory, default grants the power of sale by the trustee to payoff the lien. 

A note is evidence of a debt. A mortgage is a secured debt. In title theory states the note or evidence of the debt is made together with the security agreement, deed of trust sets the title in trust. In a lien theory state, a deed of trust is a lien against title held in trust. 

There can be many issues that arise from either theory, one misconception about title theory is that a lender can end up with legal title after a default and simply own the property with all the bundle of rights. While technically true, this is clouded by laws of equity.

I'm not speaking so much about equitable interests (but there are) but to "courts of equity" where a lender may be held to a degree of fairness. No lender is going to end up owning a million dollar property when they are only owed ten thousand dollars, nor will the be allowed to keep greater proceeds from any sale over what they were legally owed. The foreclosure system is not a profit center for a lender, the concept is for a lender to be indemnified or made whole. 

I won't go into foreclosures, but laws of equity as well as homestead laws and redemption rights also play on a lender's right to take title and possession. Is it equitable for a lender who extended a cash loan to take a property and evade the equitable interests held by a borrower/owner, by not selling the property allowing the borrower to obtain excess equity of what the lender was owed? No. In courts of equity, the lender is to be made whole, not rich. This only applies to loans funded with cash or by other assets. 

Equity loans, where we have seller financing, the lender loans equity based on a stated sale price. Upon default of an installment contract the contract to purchase becomes void, ineffective and inoperable. The sale is terminated, that then sets aside amounts owing sense that amount is based on an agreed price in that sale. The legal title reverts back to the seller as if the sale had never taken place. That also means that lender is not entitled to any deficiency judgment of equity financed based on a sale that was terminated. This comes from uniform laws concerning installment sales, but some courts may hold the contract at a higher standard as a breach of contract, but not many. 

This is about as deep as any investor or Realtor needs to go as to theory, it gets more complicated, but for those who aren't in loan servicing or in law, we just don't need to dig into theory. 

Hope this longer version helped. You can pick up more in my course, as to different aspects on the investor level, what holds us to the due on sale provisions, lender's rights to protect collateral, borrower's obligations, equity interests, etc. 

My morning coffee post, LOL :)  

[Account Closed]

@Bill Gulley

Another excellent post.

[Roy N.]

@Bill Gulley @Rich Hupper

A little diversionary word fun for a Sunday morning.

While the roots are ultimately in latin (mortuus), mortgage comes to English from Old French, mort gage (literal translation: dead pledge)  - the name arises from the fact that the deal dies when either the debt is paid or payment fails.   Ironically, though the term mortgage survives in English, in modern French it is called hypothèque.

[Brian Gibbons]

Originally posted by @Roy N.:

@Bill Gulley @Rich Hupper

A little diversionary word fun for a Sunday morning.

While the roots are ultimately in latin (mortuus), mortgage comes to English from Old French, mort gage (literal translation: dead pledge)  - the name arises from the fact that the deal dies when either the debt is paid or payment fails.   Ironically, though the term mortgage survives in English, in modern French it is called hypothèque.

 Perhaps that is where we derive "hypothecate" from

Definition: to pledge as security without delivery of title or possession.

[Roy N.]

Originally posted by @Brian Gibbons:

 Perhaps that is where we derive "hypothecate" from

Definition: to pledge as security without delivery of title or possession.

 Hypothecate and hypothèque draw their origins from Greek ὑποθήκη ‎(hupothḗkē) via Latin, hypothēca.  My etymology dictionary is not clear if the word made its way from Latin to English via French - this is the typical common path, but "mort gage" was still in use in French at the time of Normandy (and for sometime after), so perhaps it came directly into both languages from Latin.

{Note:  It took me way too long to figure out how to input those characters on my keyboard - I had to fire-up my old APL interpreter}

[Rich Hupper]

@Bill Gulley

Great explanation. I will definitely need to reread it again. The theory of title interests me, I guess that is why I am digging into it more so than other people would.

Bill would you happen to know anything about allodial title? I have read articles on the web that alludes to real estate owners owning property in the highest degree free from any creditor, including taxes. 

[Bill Gulley]

Have you met General Allodial on GREA? He is the Commandant of the Academy, LOL.

The Allodial system in the US is still subject to police powers by government. I cover it basically in the beginning of my course, when all the land was owned by the king who granted lords the right of use who in turn rented the land as a tax. In the 13th Century the Allodial system was granted giving individuals the right to own land that would be passed by inheritance or by sale. That's when investing began! (Nothing is new in real estate, LOL)

The only lands I'm aware of without taxation are from Indian grants, and they aren't selling! I'm not aware of tax free land after ownership is taken, perhaps governments lands and in Alaska under land settlement laws, so folks get paid the live there, LOL. 

Tell us what you find out  @Rich Hupper  :)

[Rich Hupper]

@Bill Gulley

I have not spoke to General Allodial on GREA. I do like his name. The web article I read about land patents and Allodial title is found below...

http://www.freedomforallseasons.org/AllodialLandPa...

I knew it sounded too good to be true but it is an interesting read none the less.

These land patents have interested me enough to seek out title examiners and see if any of them would be willing to let me shadow them. I would be interested to see how far back they can follow the chain of title at the local registry of deeds. I know most examiners only go back 50 years for the typical residential real estate transaction. 

[Bill Gulley]

Originally posted by @Rich Hupper:

@Bill Gulley

I have not spoke to General Allodial on GREA. I do like his name. The web article I read about land patents and Allodial title is found below...

http://www.freedomforallseasons.org/AllodialLandPa...

I knew it sounded too good to be true but it is an interesting read none the less.

These land patents have interested me enough to seek out title examiners and see if any of them would be willing to let me shadow them. I would be interested to see how far back they can follow the chain of title at the local registry of deeds. I know most examiners only go back 50 years for the typical residential real estate transaction. 

Don't hold your breath, I've seen legal descriptions using landmarks; to the center of a large oak tree, to the edge of the rock outcropping, to the double fence post back to the beginning (leaving out distances in links and chains). Well, the posts are gone, the tree fell, the bluff peeled off from erosion, so where are the corners? That's what you get when you go back 100, 150 years! :)    

[Rich Hupper]

Hi @Bill Gulley and @Brian GibbonsI bought the book mastering real estate principles by Gerald R Cortesi and have been enjoying the read. 

I do have to say I am still confused about some things. If either you have the time to comment I would be greatly appreciative. 

First. A land trust is a trust where real estate is the only asset held in the trust. Legal title is held by the trustee and the trustor becomes the beneficiary. The book goes on further to describe that land trusts convert the ownership benefits of real property to personal property. This beneficial interest may be pledged as collateral for a loan without a mortgage being placed in the public records. What does this mean? The book does not provide a example.

Secondly, when it comes to a deed of trust I am confused once again. I know this serves the same purpose as a mortgage except it is not a lien like a mortgage would be. Instead it is a trust. The book says it involves 3 parties the trustor ( mortgagor, borrower ) the trustee ( the bank or title company ) the beneficiary  (the mortgagee ,the lender ). 

Now in massachusetts we do not have title companies do closings we have closing attorneys who work for the lender funding the purchase. I am trying to understand exactly what happens at closing. 

1) The seller brings his deed to the closing table signs it and gives it to the buyer to sign.

2) The buyer accepts the deed and for just a few seconds has full legal title to the property. Then hands the deed over to the closing attorney. ( is the closing attorney the trustee for the deed of trust or is he an agent for a trustee who works for the lender or is the trustee a filing cabinet at the lenders office?)

3) The attorney then has the buyer sign all the documentation for the promissory note and the security instrument. 

4) At the end of the closing the seller usually leaves with a check and the buyer leaves with a bunch of papers saying he now owns an equitable interest in a piece of real property located at blah blah blah. 

5) The lender is now the beneficiary of this deed of trust but what is the buyer once this deed of trust is created? Does the buyer continue to be the trustor or does he become a trustor and a beneficiary at the same time? 

Also the book mentions that the trustee is given naked or bare title rather than actual title. I thought the trustee received legal title to real property with deed of trust, and equitable title was given to the beneficiaries. 

Thank you for your continued help.

[Douglas Snook]

Rich

You are confused a little about a closing in MA. The buyer does not sign the deed. usually the deed is only signed by the seller and it indicates who the buyer is, whether individual, trust, corporation, LLC etc. The deed is usually filed immediately at the registry of deeds, the lawyer does not hold it. If there is going to be a mortgage and note etc, then the lawyer makes sure those are executed correctly and usually just the mortgage is recorded at the registry as well while the lender will hold the note (and gets the mortgage back once it is recorded). If the property is going to go into a trust, usually the trust is recorded first then the deed. The Schedule of Beneficiaries of the Trust are usually not recorded but held by the Trustee. The trustee may or may not be a beneficiary and the trustee usually can only act with regard to the property (ie sell it with consent of the beneficiaries) All depends on what the trust says.

Your number 5 makes no sense to me at least as far as MA is concerned (in my opinion) Some states but not MA consider the mortgage an actual transfer of the ownership interest in the property. MA does not use the term "deed of trust" usually.

Not sure if that helps just my two cents

[Bill Gulley]

As Douglas mentioned, you're mixing apples and oranges. A "Deed of Trust" is a deed that conveys certain and specific powers to a trustee by agreement, it is not a Trust entity that is`established to manage or hold assets for the benefit of a beneficiary. A Deed of Trust is an agreement that sets conditions, so long as a borrower meets the conditions of a` mortgage or note and the terms of the deed, the Trustee under a Deed of Trust has no powers of ownership. 

A Trustee of a`Land Trust or any other Trust takes actual title to the real property for the benefit of the beneficiary. Saying real property is converted is not accurate, the property rights of real property remain and are under the ownership of the Trust and control  of the Trustee. The ownership of the Trust, rights to benefit from that Trust are personal property, just as if you owned stock in a company, your stock is personal property but you don't "own" the assets or factories held by that company. 

A seller doesn't bring a deed to settlement, a new deed, evidence of ownership, is made conveying ownership rights held by the seller to the buyer and the buyer is the grantee, they don't execute a conveyance deed. The grantor is the seller and they grant rights over to a buyer. 

In a`lien state, I loan you money, you sign a deed of trust, that trust is limited and my Trustee can only act under the powers granted by that deed. I have a special lien against the title to the property by agreement.  In a title state, legal title passes to the Trustee conditionally, they hold title but may not exercise any powers of ownership so long as the borrower meets the conditions of the deed and note. Think of it as a conditional sale, you don't get full title until you meet the terms of paying off the obligation as agreed. If you default on the obligation, I foreclose on your equitable interests in title, as well as other rights such as homestead exemptions and rights of redemption,  I already have legal title.

I'll mention too, in a seller financed mortgage, equity is financed based on an agreed sale price, this is not a cash advance loan. That means that the sale is conditioned upon paying as agreed. In a lien state, title passes to my buyer based on the terms of the note as it is a conditional sale. If there is a default of payment on that agreed sale price, the sale becomes voidable, as if the sale never took place and legal title reverts back to the seller. That seller then must foreclose on the equitable interests remaining in order to have clear title, unencumbered. So, seller financed transactions operate as a title state because the sale is a conditional sale. In a cash advanced mortgage, the sale is not conditional as the transaction is fully paid and title passes under the lien or title theory of that state. 

You'll get more meat if you take the right classes. :)     

[Rich Hupper]

@Douglas Snook@Bill Gulley Thank you both. I am definitely confusing a deed of trust with a trust entity. I can see now they are different. One is an agreement the other actually forms an entity that will have a tax id number.

What was confusing me is they both have a trustor, trustee, and a beneficiaries. 

Thank you for the clarification. 

One more thing then I think I will completely understand this. To clarify:

A deed of trust is used only in title theory states where a borrower has equitable title and the lender has legal title which is held by a trustee. This is all based on the conditions of the security instrument. When a borrow breaks one of those conditions in a non judicial state the lender does not need to seek a judgement from court to begin the foreclosure process because they already hold legal title to the property. The trustee sets up a public auction to try to satisfy the debt. If the lender does not get what they want at the auction the property will become real estate owned.

A mortgage is used only in a lien theory state where a borrower holds equitable and legal title to the property. The lender only has a right to look to the borrowers property as a security to repay a debt, this is a lien. If the borrower breaks one of the conditions in the mortgage agreement, the lender needs to seek out a judgement from the courts against the borrower before they can initiate the foreclosure sale. The foreclosure sale is conducted by a sheriff or other government official. If the lender does not get what they want at the auction to repay the debt the property becomes real estate owned.

Did I get it right this time? LOL

[Bill Gulley]

Not really, mortgage = title states, deed of trust = lien states, there are exceptions. Both provide non-judicial foreclosures in states, regardless of being a title or lien state, if that state allows a non-judicial process, otherwise the lender must go through a judicial sale. Who acts to sell any property at foreclosure is generally the trustee of the mortgage/DOT, it can be someone appointed by the court to conduct non-judicial or judicial sales, like the Sheriff, exactly how the process must be conducted is subject to state law and local custom.

The note holder enters a payoff amount, at a sale any bid exceeding that entry bid then constitutes a sale. In some states a lender may accept a bid below their payoff. If for any reason, amounts received from a sale do not extinguish the debt, the lender may sue for a deficiency judgement in states that allow such on residential property or real estate. If there is no sale then the property reverts to the lender as ORE/REO and must be sold with proceeds going to the debt for cash advanced loans in lien states. If it is sold and there are still amounts due, the revert back to obtaining a deficiency judgement, as allowed. In title states a lender may be entitled to retain a property, unless a borrower takes other actions for excess equity.

Any foreclosure in a non-judicial state can be forced into a judicial foreclosure, it is simply a law suit filed by the borrower against the lender for some breach of the process or based on another circumstance a judge may allow. 

This all goes to cash advanced loans, where a lender loaned money in the transaction. Loans arising from equity financed based on an agreed sale price do not follow the same path, because installment sales terminate and the property sold reverts title back to that seller, the seller forecloses in either manner to foreclose upon the equitable interests the buyer has. When you have installment sales that do not use terms of a security agreement (DOT) then the lender must use a judicial process to foreclose on the buyers interests.

This is as far as any investor needs to go in understanding the general process because it becomes detailed under state law, unless you plan on getting into the business of lending or being an attorney, court official or title agent. Then you need to study the state requirements where you operate......and that's a good thing to do as an investor, know what your state requires. :)     

[Rich Hupper]

Thanks again @Bill Gulleyfor trying to help me understand this. Do you offer any classes about the foreclosure process through your academy?

[Bill Gulley]

@Rich Hupper, no, not really, that's because foreclosure laws or requirements are unique to state laws and while there are uniform procedures like notice, notice of dishonor, demand, notice to creditors, publication, sale, redemption, disposal and deficiency, it all is subject to state law. And, the only folks who deal with this are attorneys, trustees and lenders, so I don't see it as an investor path. 

There is only one reason someone would become an attorney and then apply for medical school (and they would be turned down obtaining that education backwards), that's to sue doctors. Those that go this route go to med school first, then law school.  :)   

[Rich Hupper]

Thank @bill gulley. It looks like I need to find an investor friendly attorney in my area that can help.

[Dustin Verley]

I know this thread is slightly outdated but it has definitely gave me some insight. I think my concern with the whole Sub2 method of creative financing is where the exit strategies are limited based on the types of titles being conveyed. For instance, if I'm not mistaken, typical seller financing is supposed to convey both legal and equitable titles, whereas a land contract/CFD does not convey the legal title until the land contract is fulfilled.

Does this sound accurate?

[Rich Hupper]

@dustin verley. With a sub 2 deal you get a deed from the owner giving you equitable title but legal title stays with the owner of the note. You get legal title when the note is paid in full. If the loan balance is higher than the contract price of the property it would not make sense to do unless you plan to put tenants in the property or you could add value to the property and sell quickly for a decent return on what you put into it. You need to find an owner who is okay with you paying his mortgage despite the fact he is still legally obligated to pay for it not you. i would refinance or sell a sub 2 as quick as you can.