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Mortgage Lending Junior to Contract For Deed

You will find a copy of a Court of Appeals, unpublished court decision Bank Midwest, Minnesota, Iowa, N.A. v. Jerome Lipetzky, et al in Bank vs Lipetsky Court Case here.  This case should be a cause for concern to any financial institution granting financing that will be junior to an existing contract for deed.  Any time a financial institution is planning to lend money as a second mortgage to someone who is purchasing under a contract for deed, care must be given to examine the contract for deed to determine if the contract contains any prohibition on sale or other transfer.  If it has such a provision, the mortgage may be invalid.   Click here for Bank Midwest v. Lipetzky Court Case

            The court case involves a bank which put a second mortgage on a family farm.  The parents sold the farm on a contract for deed to their son.  The contract for deed contained language prohibiting transfer.  The sale price was less than fair market value.  The parents, presumably, did not want the property to go out of the family or their children to be spendthrifts. 

            The Bank Midwest put a second mortgage on the property.  The borrowers defaulted and the Bank was involved in litigation with the contract for deed sellers to enforce the priority of its junior position.

            The Court of Appeals found that the language was clear and inequivicable.  A second mortgage is a violation of the prohibition on transfer.  As such, the Bank's second mortgage was void.  The contract for deed was of record; therefore, the Bank had notice of the contract for deed and its terms therein. 

            The practice tips for any Lender in these kinds of circumstances are as follows:

1.     Obtain a title insurance policy insuring the priority of your second mortgage.  If you are aware there is a prohibition on sale, please make sure you bring this to your title insurance carrier's attention in writing.  If the title agency proceeds to insure your loan after you have given them notice, you will be covered.

2.     The second alternative for the second mortgagee would be to carefully examine the record for all of the terms of the contract for deed and any possible amendments thereto.  If there is language prohibiting transfers, sales, or assignments, do not proceed with the loan. 

3.     If the bank wants to be very cautious, it can obtain an estoppel letter from the contract for deed vendor.  This is always a good idea.  The estoppel letter could include items such as:

a.   principal balance outstanding,
b.   whether the contract for deed purchaser is current on all their obligations,
c.   an affirmation that the contract for deed of record is a true and correct copy of the contract for deed,
d.   a statement that there are no amendments, addenda or modifications to the original contract for deed, and,
e.   a statement that there is no prohibition on transfer in the agreement between the contract for deed sellers and the contract for deed purchasers and no prohibition on junior financing.

We have been asked many times what a financial institution may need to do to put a second mortgage on property that is being purchased under a contract for deed.  Clasically, the lender needs to place its mortgage of record like a regular second mortgage.  The bank, as an "assign" of the contract for deed purchaser would need to be served with notice of any foreclosure proceeding.  Because of this case, the simple answer is no longer appropriate.  Further inquiry is necessary.

Many times financial institutions ask the contract for deed seller to join in the mortgage.  This has the effect of giving the bank the first lien position.  Check with bank counsel on the proper procedure for handling this type of loan transaction.  It is important that the bank document the consideration the contract for deed seller is receiving to justify their loss of a first lien position.  Otherwise, the grant of the mortgage as a first lien position may be voidable for lack of consideration.  Very few people other than parents would agree to subordinate their contract for deed seller first position.

On that same note, if the bank asks the contract for deed seller to join the mortgage, we are always worried that the contract for deed seller (or contract for deed vendor) may not understand the gravity of their actions.  They may feel that they are just signing as an accommodation for the bank to get a second position on the property, not realizing that the bank is asking to be in first position. 

Practice tip:  Have the contract for deed seller sign a document stating they understand they are pledging their property as collateral for the contract


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