by: Peter J. Gallagher (@pjsgallagher)
New Jersey is a "race-notice" jurisdiction when it comes to mortgage priority. What this means, in its simplest terms, is that if Party A obtains a mortgage on a piece of property before Party B does, but Party B records its mortgage first (i.e., it wins the "race" to the clerk's office), then Party B's mortgage has priority unless Party B had "actual knowledge" of Party A's previously-acquired interest. But what happens when a first mortgage is refinanced? The original mortgage is technically paid off and replaced with the refinanced mortgage. Does this "newly-recorded," refinanced mortgage maintain the first priority status of the original mortgage or does it go to the back of the line? The answer to this question — as discussed in a recent decision from the Law Division, Wells Fargo Bank, NA v. Kim — is that the refinanced mortgage generally takes the original mortgage's first priority position.
In Kim, defendant borrowed $328,000 from Washington Mutual Bank, FA ("WaMu") to buy a home and secured repayment of this loan with a purchase money mortgage on the home. Later, defendant obtained a home equity loan from Plaintiff, Wells Fargo Bank, N.A. ("Wells Fargo") that was also secured by a mortgage on defendant's home. Defendant then refinanced her original, purchase money mortgage with WaMu. Defendant used the entire amount of the refinance loan, which was secured by a mortgage on defendant's home, to pay off the original purchase money mortgage (i.e., she did not borrow and more money through the refinance) and the purchase money mortgage was discharged of record. WaMu did not obtain a subordination of the Wells Fargo mortgage in connection with the refinance.
Approximately three years after the refinancing, defendant defaulted on the Wells Fargo home equity loan, and Wells Fargo moved to foreclose. Defendant did not file a contesting answer and the court entered default against her. However, U.S. Bank Trust, N.A. ("U.S. Bank"), the successor to WaMu's interest in the refinance loan and mortgage, filed a contesting answer claiming that its mortgage stood in first priority position ahead of Wells Fargo's mortgage.
The trial court agreed with U.S. Bank. The court acknowledged that the general rule is that the party that records its mortgage first has priority. But, the court noted that this general rule was not "immutable," and was subject to "certain equitable considerations." One of these equitable considerations arises when a mortgage loan satisfies and replaces a prior mortgage loan by the same lender. In this situation, absent material prejudice to a junior lien holder, the replacement loan takes the same priority as the prior loan "under the principles of mortgage modification and replacement." Moreover, in this context, the lender's "actual knowledge of an intervening lien is not a bar to its reliance upon equitable principles of priority." In other words, in Kim, even though WaMu knew about the Wells Fargo mortgage at the time of the refinance, the refinance mortgage still inherited the original, purchase money mortgage's first priority status.
In light of these principles, the court concluded that U.S. Bank was entitled to first priority status over Wells Fargo and that this decision was not "materially prejudicial" to Wells Fargo. On the latter point, the court held that the proceeds from the refinanced loan were used only to pay off the original, purchase money mortgage. This factor alone "weigh[ed] heavily against the finding of prejudice." In addition, the refinanced loan provided defendant with a lower interest rate and extended the term of the loan, both of which were not prejudicial to, but actually improved, Wells Fargo's position. Accordingly, the court held that Wells Fargo would not be "materially prejudiced" by U.S. Bank maintaining the first priority status that was secured by the original, purchase money mortgage. Finally, the court held that there was no requirement that WaMu obtain a subordination from Wells Fargo when it refinanced the original, purchase money mortgage.
With interest rates at historical lows, refinancing has been a popular practice over the past several years. Although the law on this issue is not new, Kim provides a good primer for lenders and their counsel about priority when there are junior liens behind the senior lien being refinanced.