Setting Priorities: When You Refinance A First Mortgage, Is It Still A FIRST Mortgage?

by:  Peter J. Gallagher (@pjsgallagher) (LinkedIn)

Mortgage modification (pd)It is a question I have been asked a number of times over the past few years: If a lender refinances an existing mortgage, does the new lender step into the shoes of the old lender in terms of priority? In other words, if you refinance a first mortgage, does it remain a FIRST mortgage or is it a new mortgage that is junior to other mortgages that may have been recorded after the first mortgage? Granted this is not a question as weighty as, say, "what is the meaning of life?" but if you are a lender, it is an important one. I have written about this topic before, but the Appellate Division's recent decision in Ocwen Loan Services, Inc. v. Quinn, added a new wrinkle. In that case, the question was whether a refinanced first mortgage retains its first status over a life estate, as opposed to another mortgage or lien, that was recorded prior to the original mortgage.

In Ocwen, defendants conveyed their residential property to their daughter but retained a life estate in the property. (In other words, the daughter owned the property, but defendants could live there until they died.) One year later, defendants, their daughter, and her husband acquired a loan from plaintiff that was secured by a mortgage on the property. Two years after that, the daughter refinanced the mortgage for a higher amount. The title commitment that plaintiff obtained did not disclose the recorded life estates, so defendants were not required to sign the mortgage. Through the refinancing, the daughter, among other things, paid off the prior mortgage, which defendants had signed.

Two years later, the daughter defaulted on the refinanced mortgage and plaintiff foreclosed. The parties cross-moved for clarification on the status of defendants' life estate. Plaintiff argued that the life estate was subordinate to the refinanced mortgage, meaning defendants could not rely on it to stop the foreclosure. Defendants argued that the foreclosure had to be dismissed because "they did not sign the [refinanced] mortgage nor pledge their life estates in connection with the [ ] loan refinancing." 

The trial court granted plaintiff's motion and denied defendants' motion. The general rule in New Jersey is "first in time, first in right," which means that if you are the first one to record your interest in real property — mortgage, lien, life estate, etc. — then you have priority over all later-filed interests. There are equitable exceptions to this rule, however, when it comes to mortgage modifications, and the trial court applied one of these exceptions in Ocwen. The trial court allowed plaintiff to "step into the shoes of its prior mortgage which its own funds satisfied." As a result, plaintiff could foreclose, notwithstanding defendants' life estate. The trial court rejected defendants' argument that they were not bound by the refinancing because they did not sign it. Specifically, the trial court held:

Defendants signed [the original mortgage] as possessors of a life estate. While defendants may have signed the mortgage as an act of kindness and love to their daughter, the fact remains defendants were parties to the [original] mortgage and thus subjected their life estate to this foreclosure action . . . . Enforcing the refinanced mortgage against defendants puts them in the same position they were in as signers of the original mortgage. The life estates of defendants are subject to the refinance because of their participation in the signing of the original mortgage.

Defendants appealed, but the Appellate Division affirmed the trial court's decision. It held that, when dealing with the replacement or modification of a mortgage, prejudice to the "intervening lienor" is the key issue. If there is no prejudice, then the refinancing lender steps into the original lender's shoes. In Ocwen, the Appellate Division agreed with the trial court that the "replacement of the [original] mortgage with the [refinanced] mortgage did not prejudice defendants in any meaningful way." As the Appellate Division observed, :"[i]t [was] without doubt that defendants agreed to subordinate their life estate to the lien of plaintiff's [original] mortgage." Therefore, the Appellate Division held that "enforcing the [refinanced] mortgage against defendants put[] them in the same position they were in when they signed the [original] mortgage."

Finally, the Appellate Division approved the decision by the trial court to "cap" the amount of plaintiff's priority at the amount of the original loan. As the trial court held, "to the extent that the refinance exceeds the value of the [original] mortgage, such a portion of the refinance does not maintain priority over defendants' life estates." So, if you are keeping score at home, the priority stands as follows: (1) the refinanced mortgage up to the original loan amount; (2) defendants' life estate; (3) the balance of the refinanced mortgage. Thus, while defendants could not stop the foreclosure, they might be able to share in some of the proceeds of the sale of the property if a sheriff's sale resulted in payment above the original loan amount.

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