Lenders and borrowers often enter into loan modification agreements to change the terms of a mortgage loan. Perhaps the most common modification arises when the borrower is experiencing difficulty repaying the loan according to its original terms, and the lender, seeking to preserve the loan as a performing loan, agrees to reduce the monthly payments and extend the repayment period.
A second type of loan modification occurs when the loan is delinquent and the lender agrees to capitalize the past-due payments by adding the delinquent amount to the loan’s principal balance, thus making the loan current. The loan repayment period may be extended, depending on whether the required monthly payment amount will increase, decrease or remain unchanged.
There are a variety of other loan modifications that are based on the particular circumstances involved. For example, the parties may agree to have the lender advance new money to modify a previously closed-end loan, or they may agree to have substitute or additional collateral as security for the loan.
Will a first mortgage lender risk losing its lien priority to a junior lienholder if the lender enters into a loan modification agreement? It depends. The issue was addressed in Bayview Loan Servicing, LLC v. Vasko1 a case decided by the Sixth Appellate District of Ohio on January 5, 2018.
In the Vasko case, the borrower gave plaintiff's predecessor-in-interest a first mortgage in 2008. In 2012, the borrower gave a second mortgage to a different lender. In 2014, the plaintiff and the borrower entered into a loan modification agreement referencing the 2008 note and mortgage, reducing the interest rate and the monthly payment amount, and extending the loan's maturity date.
In 2016, the plaintiff filed a foreclosure action. The second mortgage holder challenged the plaintiff's lien priority in that action, arguing that the plaintiff's lien priority should not relate back to the 2008 mortgage, but rather to the 2014 loan modification agreement. The second mortgage holder argued that by entering into a loan modification agreement in 2014, the plaintiff lost the priority of its mortgage over the second mortgage holder's 2012 mortgage.
The court's decision followed the Fourth Appellate District Court of Ohio's Community Action Commt. of Pike Ct., Inc. v. Maynard2 decision, which was based on similar facts: the modification granted an extension of the repayment period and reduced the monthly payments, but did not provide additional funds or increase the interest rate. The court in Maynard relied on an Ohio Supreme Court case, Riegel v. Delt,3 which held that in order for a change in the form of the note, or the mode or time of payment to operate to discharge the mortgage, the change must amount to an actual payment of the debt or an express release. Consequently, the mortgage retained its priority.
Lenders considering a loan modification agreement should obtain a title examination of the property involved to determine whether there are other liens on it. The Maynard case suggests that even if the title examination shows junior liens, the mortgage's priority is not at risk if the modification agreement simply reduces the payment amount or extends the term.
Thus, according to the Maynard case, if the modification consists merely of a reduction in the payment amount or an extension of the loan's repayment period, the mortgage’s lien priority is not affected by the modification, even in the absence of a subordination agreement signed by a junior lienholder.
However, a mortgage's lien priority can be at risk with other types of loan modification agreements. For example, if the modification provides for the lender to advance new money on a previously closed-end loan, a junior lienholder, in the absence of a subordination agreement, could claim priority over the amount of the newly advanced funds.
Cases where there are mechanic's liens on the property can be especially complicated. Ohio Revised Code Section 1311.14 provides criteria to determine which lien is entitled to priority in construction, repair or renovation situations. The concluding statement of that statute provides that the statute: (1) controls over all other statutes pertaining to mechanic's liens; (2) shall be liberally construed in favor of mortgagees contemplated by the section; and (3) provides that substantial compliance by the mortgage holder is sufficient.
However, that statutory provision does not alleviate all concerns for the lender. If a mechanic's lien has been filed, or even if work or materials have been furnished or supplied for the property and no mechanic's lien has yet been filed, cases presenting priority disputes between mortgage holders and mechanic's lienholders can be problematic.
When considering a loan modification, the lender should be especially diligent if the title examination shows a mechanic's lien on the property, or when there is evidence that work has been performed or materials have been delivered to the property for construction, repair or renovation. For example, if the modification adds new collateral not referred to in the original mortgage, and the contractor, subcontractor or materialman has not signed a subordination agreement, the lender may have a difficult issue to litigate if a mechanic's lienholder raises a priority dispute in a foreclosure action.4
In all cases, the lender can ensure the priority of its first mortgage by obtaining a subordination agreement signed by the junior lienholder. If the loan modification circumstances present any concern about a risk of loss of lien priority, and a subordination agreement is not easily obtainable, the lender can procure an endorsement to its loan policy of title insurance and thereby transfer that risk to the title insurance company.
As always, lenders should use every opportunity during negotiations with the borrower to verify the borrower's personal, financial and credit information. Not only is this information important in evaluating the likelihood of the borrower fulfilling the loan modification agreement terms, the information is very valuable to the lender's attorney in pursuing collection.
For a copy of the Vasko case, click HERE.
For more information on this topic, please contact Larry R. Rothenberg, Esq. Mr. Rothenberg is an attorney with more than 35 years of legal experience who has been recognized by Martindale-Hubbell as a leader in his field, and has been selected in multiple editions of Ohio Super Lawyers. He is a shareholder in Weltman’s Real Estate Default Group in Cleveland, Ohio.
1 Bayview Loan Servicing, LLC v. Vasko, 2018-Ohio-38 (Jan. 5, 2018).
2 Community Action Commt. of Pike Ct., Inc. v. Maynard, 4th Dist. Pike No. 02CA695, 2003-Ohio-4312 (Aug. 12, 2003).
3 Riegel v. Delt, 119 Ohio St. 369, 164 N.E. 347 (1928).
4 See Panzica Constr. Co. v. Bridgeview Crossing, LLC, 2015-Ohio-3478, 39 N.E.3d 529 (Aug. 27, 2015).