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Payoff Statements
• If all payments are made on schedule, the mortgage debt is fully “paid off” at its originally scheduled maturity date
• Today, most mortgage notes are prepaid (before the originally scheduled maturity), either on
– (a) sale of the mortgaged land, or
– (b) refinancing by the mortgagor
• How does mortgagor confirm the amount needed to make full payment of mortgage debt?
• Mitchell contracts to buy mortgaged land from Uphoff
• Bank provides Uphoff with “payoff amount” of $125,000
• Uphoff pays what he believes to be the correct balance of $124,000
• Bank accepts the payment, but refuses to record a mortgage release
• What happens:
– If Uphoff was correct?
– If Bank was correct?
• Common law: lender had no legal duty to provide a “payoff statement” (confirmation of balance of debt)
– Compare UCC § 9‐210 (which requires secured party to confirm balance of debt upon written request)
– Restatement of Mortgages § 1.6 recognizes a legal duty; such a duty is also imposed by statute in some (but not all) jurisdictions
• In practice, lenders routinely provide payoff letters (often for a fee, unless prohibited by statute) Problem 1
If Bank Gave Correct Payoff
• Uphoff’s payment of $124,000 did not satisfy the mortgage debt
– No “accord and satisfaction” (b/c the mortgage loan is a liquidated debt, not subject to bona fide dispute)
• Uphoff still owes $1,000; the mortgage remains valid to secure payment of that amount
• If Mitchell completed the purchase, he took the land subject to the lien of Bank’s mortgage
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• By contrast, if Uphoff’s calculations were correct, then Uphoff’s payment of $124,000 satisfied the mortgage debt and extinguished the lien of the Bank’s mortgage
• Problem: if the Bank’s mortgage/deed of trust still appears on the public land records, it’s a cloud on title (searchers won’t know that it has been paid off, and may think it is still valid)
• Thus, mortgagee must execute a “release” or “satisfaction” of the mortgage
– In many states (MO), mortgagee must also record it
Mortgage Releases
• State laws vary dramatically
– In many states, statutory penalty for not recording a mortgage release is a slap on the wrist ($25‐50)
– MO = $300/day, up to 10% of mortgage debt
– NE = $5,000
– SC = amount of penalty is in discretion of judge, up to principal amount of the mortgage!
Missouri Statute [RSMo. § 443.130]
• Once mortgage is paid off, mortgagee must record release within 45 days after request by mortgagor; mortgagee who fails to do so is liable for damages caused by failure to do so
• Also, mortgagee who fails to do so is liable for statutory penalty of $300 per day (up to 10% of the amount of the mortgage), plus court costs and attorney fees (even if there are no actual damages)
• If release is rejected by the recorder, mortgagee has 60 days (after notice of rejection) to record a sufficient release
• Same problem, but now assume Bank provided a payoff amount of $124,000
Problem 2
– Uphoff tendered that amount, then deeds the land to Mitchell
• 1 week later: Bank says “Sorry, the payoff letter was wrong; it should’ve said $125,000. Pay the other $1,000 and we’ll release the mortgage.”
• Can Bank collect $1,000 from Uphoff? • Can Bank foreclose against Mitchell if Uphoff doesn’t pay?
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• Lambert owns Free Market Shopping Center
Mistaken Payoff Amount
• Bank can still collect remaining $1,000 from Uphoff
(Uphoff is personally liable for debt, which has not been satisfied)
• Bank probably can’t enforce mortgage lien vs. Mitchell (equitable estoppel)
– Mitchell reasonably relied upon accuracy of payoff amount to complete the purchase (but whether his reliance was reasonable may depend on whether payoff statement was “qualified” in any way by Bank)
“Perfect Tender in Time” Rule
• Traditional rule: if mortgage is silent, mortgagee can refuse prepayment. Rationale:
– Lender should be able to get the benefit of the investment decision it made at time loan was made
– E.g., if current interest rates are now below the contracted‐for rate, the lender will suffer a “reinvestment loss” due to the prepayment
• In “remedies” terms, does it make sense to give mortgagee the right to specific performance of the promise to repay in accordance with the note? Prepayment
– Equitable holds a mortgage on the Center, securing a $10MM mortgage loan (8% interest)
– Mortgage is payable in full at end of 10‐year term, in a “balloon payment,” in 2019
• In 2014, Lambert wants to pay off mortgage early, and tenders $10MM to Equitable
• Can Equitable refuse this prepayment?
“Perfect Tender in Time” Rule
• It is true that prepayment by the borrower will impose a reinvestment loss on the lender, if interest rates have declined in the interim
• But, money damages would inevitably make the lender “whole” (lender can presumably calculate its actual reinvestment loss)
• So why not let the borrower prepay (i.e., breach the contract), as long as the borrower pays lender for the damages the lender suffers as a result of the borrower’s breach?
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• Restatement § 6.1 rejects the “perfect tender in time” rule altogether; if a mortgage is silent, the mortgagor can prepay w/out a fee (i.e., prepayment is not a breach of the agreement)
– Fannie/Freddie single‐family note form allows prepayment w/out a fee (this has cultivated an expectation among lay persons that mortgage loans can be freely prepaid)
– Lender that wants to restrict prepayment should bear the burden of imposing clear contractual restrictions
• But: only two states (PA, MO) accept this view; the rest still apply the “perfect tender in time” rule
• Lambert owns Free Market Shopping Center – Equitable’s mortgage on the Center provides for a prepayment fee = “6% of the amount prepaid”
• Lambert wants to prepay (balance = $10MM)
– At the time of the proposed prepayment, prevailing interest rates are now 10%
Prepayment Clauses
• Mortgage loans typically one of the following types of prepayment provisions
– (1) “Lock‐out”: prepayment is absolutely prohibited, or prohibited for a certain period
– (2) “Flat fee” (fee based on % of amount prepaid)
– (3) Yield maintenance clause (fee based on formula designed to calculate actual reinvestment loss) Problem 3
• Here, Lambert’s prepayment will actually benefit Equitable!
– Interest Equitable earns on existing note = $800K/year
– Interest Equitable would earn on principal at now‐
prevailing 10% market rate = $1MM/year
– Prepayment puts Equitable in a position to increase its return on principal by $200K/year
– With 5 years left on mortgage term, present value of this benefit to Equitable ≈> $750K!
• Should Equitable be able to impose a $600K fee for prepayment when it not only suffered no loss, but received a ≈$750K benefit?
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Problem: On a 10‐Year, $10MM Loan, What Is Lender’s Loss Due to Prepayment (for Each 1% Decline in the Interest Rate)?
• Weight of authority: percentage prepayment fee clause = valid liquidated damages clause, which can be enforced without regard to actual loss
– Rationale: at time of loan, can’t know if rates will go up/down, or by how much (size of possible loss uncertain)
– Percentage fee is a “reasonable” pre‐estimate of damages due to potential reinvestment loss
• Whitman: percentage fee is effectively an “option” to prepay, and should be enforceable according to its terms (w/out regard to “penalty” analysis)
• Problem 3(d): Lambert defaults and stops making monthly payments
• After several months, Equitable accelerates the loan and demands full payment from Lambert
• Lambert then tenders $10MM and says “Now that you’ve accelerated, this is a ‘payment,’ not a ‘prepayment’ — and that means I don’t have to pay the $600K prepayment fee.”
• Is Lambert correct, or not?
•
•
•
•
•
After Year 1: $625,000
After Year 2: $574,000
After Year 3: $520,000
After Year 4: $462,000
After Year 5: $399,000
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•
•
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After Year 6: $331,000
After Year 7: $257,000
After Year 8: $178,000
After Year 9: $92,000
• Westmark [p. 548]: court allowed lender to impose prepayment fee upon payment following acceleration
– Equitable’s reinvestment risk is the same, whether the payoff is voluntary or involuntary
– But note: the mortgage language in Westmark was explicit — it allowed the lender to impose a prepayment fee if payment occurred following acceleration of the loan! [p. 549]
• If mortgage isn’t explicit, the weight of authority is that Lambert’s payment a er accelera on ≠ “prepayment” [LHD Realty, p. 550; note 4(a), p. 555]
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Yield Maintenance Clauses
• Parties can’t be certain about future interest rates, but they can use a formula that would more precisely calculate the lender’s reinvestment loss due to prepayment
– Note 2, page 553: prepayment fee = present value of all future P&I payments on the note (discounted at the “reinvestment rate”), minus the outstanding principal balance due on the note at the time of the prepayment
Usury
• Usury laws establish a legal limit on interest rates
• Nominally, Missouri has a 10% usury limit [RSMo. §
408.030]
• Traditional rule: can’t enforce usurious interest rate
– Some state laws required disgorgement of all interest collected
– Other states required only disgorgement of all interest collected above the legal rate
Questions
• Does this “yield maintenance” formula accurately reflect the lender’s damages?
• If this formula works, why would a mortgagee choose to use a “percentage fee” provision?
• Suppose mortgage stated that fee = greater of (a) yield maintenance formula or (b) 1% of the amount prepaid. Is that enforceable?
• In the 1970s/1980s, when inflation and interest rates skyrocketed, usury laws threatened the solvency of banks and S&Ls
– S&Ls were having to pay 12% to attract deposits but were prohibited from charging borrowers more than 10% (unless the state would raise the usury limit)
• Cost of potential bailout prompted federal pre‐
emption of state usury laws, allowing federally‐
regulated lenders to make mortgage loans w/out regard to state law usury limits
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• Today, due to federal pre‐emption and state law modifications, usury law is mostly a dead letter
– E.g., federally regulated mortgage lenders are not subject to state law limits
– E.g., payday lenders in Missouri are subject to maximum interest rate of 1,950%
• MO: parties can agree to any interest rate for:
– (1) A loan to a corporation, partnership, or LLC;
– (2) A business loan of => $5,000;
– (3) Loans secured by real estate, unless it is residential real estate and the lender isn’t a federally regulated lender [Do you see the usury trap here?]
Late Fees and Default Interest
• Suppose that Borrower defaults and Lender imposes a default interest rate, and also assesses a “late fee” on late payments made by Borrower
• Is that “double counting” (collecting twice for the same harm) by Lender?
Late Fees/Default Interest: Westmark
• Mortgage: “If the unpaid balance hereof is not received by Holder on the Maturity Date, such amount shall bear interest at the Note Rate plus two (2%) per annum (the “Default Rate”)....” [Default interest]
• Mortgage: “If any installment under this Note shall not be received by Holder on the date due, Holder may at its option impose a late charge of six percent (6%) of the overdue amount.” [Late charge]
• Default interest is “forward”‐looking; it compensates the lender for the lost opportunity cost (i.e., interest) associated with investment of principal
– Once borrower defaults (proving it is “riskier”), the default rate allows lender to “adjust” the interest rate to a rate more appropriate for higher risk
– Parties can agree to whatever interest rates they wish, subject to usury limits (which would rarely apply to commercial real estate mortgage loans), so default rate should be enforced by contract
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• Late fee is “backward”‐looking; it compensates for:
– (1) Lender’s administrative expense/burden of handling any late payments, and
– (2) Lost interest on the late payment itself (i.e., the lost use value of the late installment); if timely made, mortgagee would have been able to invest that amount and earn a return on it earlier
• Is item (2) ever duplicative of default interest? If so, when/why?
Westmark
• Court upheld both the late charge provision and the default interest provision as valid
– This is consistent w/weight of judicial authority under state law (even if late fees probably do overcompensate the lender, compared to actual harm likely to be suffered due to late payment)
– Effective state law limits on late charges and default interest are statutory in nature [note 7, page 566]
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