PURCHASE MONEY MORTGAGES
A purchase money mortgage is: "A mortgage on land executed to secure the purchase money by a purchaser of the land contemporaneously with the acquisition of the legal title thereto, or afterward, but as a part of the same transaction." 54A Am Jur 2d, Mortgages §97. Purchase money mortgages usually have priority over subsequently recorded liens on the property. Purchase money mortgages also have a super priority status above prior and subsequent judgment liens and certain other types of liens. However, the priority of a purchase money mortgage can be lost if the mortgage is either recorded incorrectly or not recorded at all.
Wisconsin and Indiana differ as to the priority of a mechanic's lienholder who supplied labor and materials before the purchase money mortgage was recorded. In Indiana the mechanic's lien relates back to when labor was performed or materials supplied by the materialmen. In Wisconsin, the date of priority of a construction lien depends upon when the work on the property was visible. Also in Wisconsin, most purchase money mortgages will have priority above mechanic's lienholders due to statutes providing priority to the mortgages of certain types of financial institutions. To create a purchase money mortgage the transaction must meet two requirements. First the money supplied by the lender must be applied to the purchase of the property. Second, the borrower must take title and execute the mortgage simultaneously. If one of these elements is not present, the mortgage does not take purchase money priority.
To create a purchase money mortgage in Wisconsin, the lender must supply the money for the borrower to purchase the real estate at the time when the borrower initially purchases the property. This is the definition of a purchase money mortgage in Wisconsin:
A purchase money mortgage is one given as part of the transaction of purchase to the vendor of real estate for all or part of the purchase money or to a 3rd person who advances all or part of the purchase money. Wis Stat §708.09.One advantage of a purchase money mortgage is that it will have senior priority over previously recorded judgment liens. In Northern State Bank v Toal, a creditor obtained a judgment against the borrower. Northern State Bank v Toal, 69 Wis 2d 50, 51, 230 NW2d 153, 154 (Wis 1975). Subsequently, the borrower executed a mortgage with the lender to purchase a home. The lender was aware of the creditor's outstanding judgment lien before the purchase money mortgage was executed. The lender foreclosed on the borrower's mortgage and the judgment creditor contested the foreclosure of its lien claiming that it had priority over the lender's mortgage. The circuit court found in favor of the lender, and held that the purchase money mortgage had priority over the judgment lien. The creditor appealed the lower court's decision.
The Supreme Court of Wisconsin affirmed the lower court's decision. The creditor argued that the judgment lien should take precedence over the purchase money mortgage because the lender had actual and constructive knowledge of the creditor's judgment lien. Id at 53, 154. However, the court held that purchase money mortgages have priority over other liens when the money from the mortgage is used to purchase the property at issue. The court held that purchase money mortgages have priority over other liens because the "purchase money mortgage is in effect a limitation upon the title which the grantee takes, rather than an encumbrance on the title conveyed." Id at 55, 156. The court relied on the holding and reasoning found in Rees v Luddington, 13 Wis 276, 1860 WL 4661 (Wis 1860). The court in Rees v Luddington explained that a purchase money mortgage had priority over other liens because the borrower did not legally acquire title to the property until the money to purchase the property was supplied by the lender:
The settled doctrine in such cases is as follows: that when property passes through a man without his having paid for it, and with an understanding that he is at once to secure the payment by a mortgage or lien on the property itself, no right vests in him except that which is subject to such payment; that to the extent of the unpaid price, he is, in contemplation of the law, never the owner until it is paid. The delivery of the deed to the vendee and his execution and delivery of the mortgage or other security for the unpaid purchase-money, are but parts of the same transaction… Their operation is contemporaneous and connected, and affords no opportunity for the liens of judgments or other creditors of the grantee to attach to the legal estate, before that of the grantor for the unpaid price. Rees v Luddington, 13 Wis 276, 1860 WL 4661, 4 (Wis 1860).In Wisconsin, a purchase money mortgage will also have priority over a later-recorded construction lien. In Wisconsin a construction lien is explained as follows:
Every person who performs any work or procures its performance or furnishes any labor or materials or plans or specifications for the improvement of land, and who complies with §779.02 shall have a lien therefore on all interests in the land belonging to its owners. The lien extends to all contiguous land of the owner, but if the improvement is located wholly on one or more platted lots belonging to the owner, the lien applies only to the lots on which the improvement is located. Wis Stat 770.01(3).Wis Stat 779.01(4) controls the priority of construction liens versus mortgages:
The lien provided in sub. (3) shall be prior to any lien which originates subsequent to the visible commencement in place of the work of improvement, except as otherwise provided by §§215.21(4)(a), 292.31(8)(I), 292.81 and 706.11(1) and (1)(m)… The lien also shall be prior to any unrecorded mortgage given prior to the commencement of the work of improvement, if the lien claimant has no actual notice of the mortgage before commencement.The important date for the priority of the construction lien is the date on which the work on the property became visible.
(EDITOR'S NOTE: The date of priority for construction/mechanics liens in Wisconsin is different than in Illinois and Indiana. The mechanic's lien will relate back to the date on which labor or materials were supplied in Indiana. In Illinois the mechanic's lien will relate back to the date of the contract not the date that actual work on the property began.)
In Wisconsin, a purchase money mortgage will typically have priority over a construction lien when the mortgage was recorded before the construction lien was recorded:
Except as provided in sub. (4), when any of the following mortgages has been duly recorded, it shall have priority over all liens upon the mortgaged premises and the buildings and improvements thereon, except tax and special assessment liens filed after the recording of such mortgage and except liens under §§292.31(8)(i) and 292.81. Wis Stat 706.11.Wis Stat 292.31(8)(i) refers to liens related to environmental recoveries and Wis Stat 292.81 refers to purchase money mortgages that were recorded before liens related to remedial actions were filed. In Wisconsin, the date of priority of a construction lien depends upon when the work on the property was visible. Wis Stat 779.01(4).
However, there are statutes providing priority to the mortgages of certain financial institutions. Wis Stat 706.11. A mortgage will have priority over a construction lien if the mortgage was executed to any of the following: United States federal savings and loan associations; the department of veterans affairs; the United States or any county located in Wisconsin; certain Wisconsin state agencies; state or national banks; or federally-chartered credit unions mortgage bankers, licensed insurers, or states savings and loan associations. Wis Stat 706.11. In these situations a purchase money mortgage will have priority if it was recorded before the construction lien was recorded: Certain mortgage liens, however, have priority if they are recorded prior to filing of the lien claim.
In Rees v Ludington, the seller contracted with the borrower to convey certain lots to the borrower in exchange for $10,000. Rees v Ludington, 1860 WL 4661, 3 (Wis 1860). The borrower agreed to improve and erect a building on the parcels of property before the mortgage was officially executed. The borrower constructed a building on the property, but was unable to pay for the materials and labor and a mechanic's lien was later filed against the property. After the borrower completed the building, the seller conveyed the property to the borrower in exchange for a bond and mortgage for the purchase money. The seller foreclosed on the mortgage and the question presented was whether the purchase money mortgage or the construction lien had priority.
The court held that the seller had priority over the construction lien holder because a purchase money mortgage was executed between the borrower and the seller. The deed continued the earlier contract between the two parties and the conveyance of the deed and the execution of the mortgage were simultaneous acts that were part of the same transaction. Due to the simultaneous effect of conveying the deed and executing the mortgage, there was not a point in time in which the mechanic's lien could have attached to the property. The court also held that the title to the property and the title to the building could not be separated. The buyer obtained title to the land as well as the property.
In Wisconsin, a purchase money mortgage will have priority over a construction lien that was recorded after the purchase money mortgage was recorded, even though labor was performed before the mortgage was executed. In Marine Bank Appleton v Hietpas, a general contractor supplied labor and materials for construction on land owned by the city starting on October 11, 1983. Marine Bank Appleton v Hietpas, 149 Wis2d 587, 589, 439 NW2d 604, 605 (Wis App Ct 1989). A borrower subsequently purchased the property and executed a mortgage with the lender. The lender recorded the mortgage on July 3, 1984, and the general contractor recorded its construction lien on October 31, 1984. The question presented was whether the mortgage or the construction lien had priority. The lower court held that the mortgage had priority over the construction lien. The appellate court affirmed the lower court's decision. The court interpreted Wisconsin Statute §706.11(1) and held that a mortgage executed to a bank had priority over a construction lien that was recorded after the execution of the mortgage. The lender's mortgage had priority over the construction lien because the mortgage was recorded before the construction lien was recorded.
In Indiana, a purchase money mortgage has priority over other judgment liens by the following statute: "a mortgage granted by a purchaser to secure a purchase-money shall have preference over a prior judgment against such purchaser." IC 32-8-11-4. The Indiana Code does not specifically define a purchase money mortgage. However the case law does shed some light on the definition and requirements for the existence of a purchase money mortgage.
In Liberty Parts Warehouse v Marshall County Bank & Trust, the borrowers executed a land contract with owner to purchase property by making monthly payments. Liberty Parts Warehouse v Marshall County Bank & Trust, 49 NE2d 738 (Ind Ct App 1984). The borrowers divorced and transferred the property to themselves as tenants in common. A creditor subsequently recorded a judgment against the husband. The husband executed a note and mortgage to the lender to purchase the property and complete the contract. The lender gave a check to the owner of property for the amount owed on the land contract. The owner deeded the property to the borrowers. The husband purchased the wife's half of the property and she deeded her interest to him. Later, the lender foreclosed on the property. The circuit court held that the lender had priority over the creditor that obtained a judgment against the husband.
The creditor argued that a purchase money mortgage did not exist because the land contract was a sale of the property and that the lender's loan was a refinance mortgage. The appellate court affirmed the lower court's decision and held that the loan was a purchase money mortgage. The appellate court defined a purchase money mortgage as "one which is given as security for a loan, the proceeds of which are used by the mortgagor to acquire legal title to the real estate." The court also established a test to determine whether the loan was classified as a purchase money mortgage: "[T]he tests employed in determining whether a mortgage is a purchase mortgage are whether the proceeds are applied to the purchase price, and whether the deed and mortgage are executed as part of the same transaction." The court held that if the loan enabled the borrower to acquire legal title in the property, then the loan was a purchase money mortgage. However, it is necessary for the loan and mortgage to be executed at the same time. If the loan and mortgage are executed at the same time, the borrower takes "the title already charged with the encumbrance." There is not a point in time that a prior judgment lien can attach.
The court held that the first part of the test was satisfied because the borrower executed the loan and the mortgage at the same time. The court held that the second part of the test was also satisfied because the borrower used the loan proceeds to acquire legal title to the property.
The holding in Brower v Witmeyer demonstrates that the recorded dates of the mortgages do not determine priority in Indiana. Brower v Witmeyer, 22 NE 975, 975 (1889). In Brower v Witmeyer the borrower purchased property from landowners. The borrower executed two mortgages for this real estate transaction; one mortgage to a financial institution for the money borrowed to pay the down payment for the property and another mortgage to the landowner for the purchase money (purchase money mortgage). The landowners deeded to the borrower at the same time as the borrowers signed the mortgage to the landowners. The borrower then executed a mortgage to a second lender for the down payment a short time after the mortgage with the landowner. The landowners entrusted their mortgage agreement to a justice of the peace, however he recorded the mortgage nine months later. The holder of the down payment mortgage recorded his mortgage before the purchase money mortgage was recorded. The holder of the down payment mortgage subsequently assigned the mortgage to another individual (assignee). The lower court held that the purchase money mortgage maintained first priority even though it was recorded after the down payment mortgage, because assignee had notice and was responsible for inquiring into the status of the title.
The Supreme Court of Indiana affirmed the lower court's decision, holding that the purchase money mortgage had priority over the down payment mortgage. The original holder of the down payment mortgage was aware of the purchase money mortgage and the secondary priority of his mortgage. The down payment mortgage could not supersede the purchase money mortgage, because the title to the debtor was conveyed at the same time the mortgage was executed. Therefore, there was no point in time during which a junior mortgage could attach to the property.
A purchase money mortgage that is not recorded may lose priority to a junior mortgage if it is assigned to another party after the purchase money mortgage was recorded. In dicta, the court discussed that if the junior mortgage had been assigned before the purchase money mortgage was recorded, the junior mortgage would have priority because the assignee would not have had notice. However, the junior mortgage was assigned after the purchase money was recorded.
In Indiana, a purchase money mortgage will not maintain priority status if a mechanic's lienholder furnished materials and labor before the purchase money mortgage was recorded. Greyhound Financial Corporation v R.L.C Inc, 637 NW2d 1325 (Ind Ct App 1994). In Indiana, IC 32-8-3-5 controls the priority of mechanic's lien over other liens and judgments:
(b) The recorder shall record the notice, when presented, in the miscellaneous record book, for which the recorder shall charge a fee in accordance with IC 36-2-7-10. All liens so created shall relate to the time when the mechanic or other person began to perform the labor or furnish the materials or machinery. Except as provided in subsection (c), all liens shall have priority over liens suffered or created thereafter, except the liens of other mechanics and materialmen, as to which there shall be no priority.A Class 2 structure has only one or two dwelling units or a building that is used as a garage, barn, or shed in conjunction with the dwelling unit. However, the outbuilding cannot be used for commercial purposes. IC 22-12-1-4; IC 22-12-1-5.
In the Greyhound case, a borrower executed a purchase money mortgage with the lender to purchase a rail line. The day after the borrower executed the mortgage with the lender, the borrower contracted with a construction company to repair the rail line. The lender recorded the mortgage three days after the mortgage was executed. Approximately six months later the construction company recorded a notice of a mechanic's lien against the borrower. The construction company foreclosed on the mechanic's lien as soon as it recorded its notice. The issue presented was whether the purchase money mortgage or the mechanic's lien had priority. The lower court held that the mechanic's lien had priority over the purchase money mortgage.
The Indiana court of appeals affirmed the lower court's decision. The court explained that once the notice for the mechanic's lien had been filed, the lien was perfected and related back to the date on which materials and labor were supplied. The court explained that a purchase money mortgage did not have priority above all types of liens. Id at fn1. The mechanic's lien had priority above the purchase money mortgage, because the date the materials and labor were furnished was before the date that the purchase money mortgage was recorded.
Unlike Indiana and Wisconsin, Illinois does not have any statutes defining or prioritizing purchase money mortgages. However, the definition and priority rules of purchase money mortgages can be found in Illinois case law. In Wermes v McCowan the borrowers purchased property from the landowners pursuant to a payment plan. Wermes v McCowan 3 NE2d 720, 286 Ill App 381(2nd D 1936). While the buyers were making payments to the landowners, the landowners purchased a separate piece of property from the lender. The buyers subsequently had two money judgments entered against them and recorded. At this time they were also unable to maintain their payments to the landowners. To relieve financial difficulties, the buyers borrowed money from lender to complete payments for the property purchased from the landowner. The buyers also executed a mortgage with the lender that was secured by the deed to the property. A couple of years later the lender foreclosed on the buyer's mortgage. However, the two creditors who recorded money judgments against the buyer argued that their liens were superior to the lender.
The court held that the lender's loan to the buyers was a purchase money mortgage and had first priority over the other liens. There was a rebuttable presumption that a purchase money mortgage was created if the mortgage was executed on the same day that title of land was conveyed. In the case at bar, however, the creditors were unable to rebut the presumption. The court clarified the two-part test to determine whether a mortgage was a purchase money mortgage: (1) "whether the proceeds are to be used to apply on the purchase price" and (2) "whether they [deed and mortgage] were part of one continuous transaction." The court noted that some courts require that the deed and mortgage be executed at the same time. However, Illinois law is a little more lenient and requires only that the acts be part of "one continuous transaction." The court referred to this rule of law as the "theory of transitory seisin." The court held that the borrowers' deed and mortgage were part of the same transaction; both were executed at the same time and place.
Although in Illinois the execution of the mortgage and the conveyance of the deed do not have to be completed at the exact same time, there cannot be a significant lapse of time between the conveyance of the deed and the execution of the mortgage. Roane v Baker, 2 NE 501, 503 (1885). In Roan v Baker, the lender conveyed property to the borrower. It was orally agreed that the borrower would pay for the property in four promissory notes, and the first three notes were to be secured by a mortgage on the property. The notes were executed and the deed was conveyed, however the mortgage was not executed until five months later. Two money judgments were entered against the borrower before the mortgage was executed. The court held that a purchase money mortgage did not exist because the conveyance of the deed and the execution of the mortgage were not part of the same transaction. In its decision, the court took into consideration the five-month time period in between the deliverance of the deed and the execution of the mortgage. As a consequence, the two judgment liens had priority above the mortgage.
A purchase money mortgage that is not recorded or recorded incorrectly will not maintain the first priority status compared to subsequent judgments recorded against the borrower. In Thorpe v Helmer, the borrower granted a deed of trust on two parcels of property to secure payment for two notes. Thorpe v Helmer, 275 Ill 86, 113 NE 954 (1916). However, the lots were incorrectly described as located in section 16 instead of section 26. Chicago Title and Trust obtained a judgment against the borrower and recorded it. When the borrower passed away, his widow included the lots by the correct legal description in the real estate inventory. The widow also indicated that the title to the lots was encumbered by the deed of trust to the lender. The property was subsequently foreclosed upon and sold to a buyer. When the buyer passed away, the incorrectly described lots were conveyed to his relatives.
The lots were eventually conveyed by the correct description, to a second buyer. The second buyer conveyed an undivided one-fourth interest to a third buyer. The judgment against the borrower was eventually assigned to an assignee. The judgment against the borrower resulted in an execution and sale of the lots in question in 1903. The issue presented was whether the judgment lien or the purchase money mortgage had priority. The lower court held that the assignee, holder of the judgment lien, did not have any interest in the property.
However, the Illinois Supreme Court reversed the lower court's decision. The court held that a judgment lien attaches to any property that the borrower owns of record. The court held that the judgment lien attached to the property at issue because Chicago Title and Trust Company did not have any actual or constructive notice of the deed of trust, because the property was incorrectly described in the record. Chicago Title and Trust Company did not have any constructive notice of the deed of trust's encumbrance of the property because the description error was not apparent on the face of the trust deed. The court held that a purchase money mortgage will be void to subsequent purchasers if it is not recorded. Id at 90-91, 956.
In certain circumstances, a mechanic's lien may be able to defeat a properly recorded purchase money mortgage. In Illinois, a mechanic's lien will have priority over a purchase money mortgage when the date of the contract predated the recordation date of the purchase money mortgage, because the lien relates back to the date of the contract. Additionally, a mechanic's lien will have priority over a previously recorded purchase money mortgage if the construction work increased the value of the property or the improvements to the property caused the property to be used at its highest and best use. The mechanic's lien statute provides in relevant part:
No encumbrance upon land, created before or after the making of the contract under the provisions of this act, shall operate upon the building erected, or materials furnished until a lien in favor of the persons having done work or furnished material shall have been satisfied, and upon questions arising between encumbrancers and lien creditors, all previous encumbrances shall be preferred to the extent of the value of the land at the time of making of the contract, and the lien creditor shall be preferred to the value of the improvements erected on said premises, and the court shall ascertain by jury or otherwise, as the case may require, what proportion of the proceeds of any sale shall be paid to the several parties in interest. All encumbrances, whether by mortgage, judgment, or otherwise, charged and shown to be fraudulent, in respect to creditors, may be set aside by the court, and the premises freed and discharged from such fraudulent encumbrance. 770 ILCS 60/16.A mechanic's lien will have priority over a purchase money mortgage if the construction contract was signed before the purchase money mortgage was recorded. A priority dispute arose between a purchase money mortgagee and mechanic's lienholders in State Bank of Lake Zurich v Winnetka Bank. State Bank of Lake Zurich v Winnetka Bank, 245 Ill App 3d 984, 614 NE2d 862, 185 Ill Dec 421 (2nd D 1993). In 1988 Lofstrom purchased a parcel of property and borrowed $600,000 from State Bank of Lake Zurich (State Bank) to build a luxury house on it. S.G. Royal, Ltd. (Royal) was the general contractor for the project, however there was no written contract. Construction on the property ran from March through May of 1988.
There were also three subcontractors involved: Ewing, Spancrete, and Brickman. Ewing and Spancrete both contracted to perform work in the middle of April 1988 and Brickman contracted with Royal on August 1, 1988. Lofstrom requested a loan from State Bank in March 1988 and the mortgage was recorded on June 29, 1988. In September 1988 Loftstrom needed more money for the project and borrowed an additional $340,000 from State Bank. The additional mortgage was recorded on October 12, 1988. Lofstrom defaulted on his payments and State Bank filed a motion to foreclose on the mortgage. The three subcontractors, Brickman, Ewing, and Spancrete, filed claims to foreclose on their mechanic's liens. The following issues were presented: (1) which recordation date was the correct date for the purchase money mortgages; and (2) whether or not Brickman's mechanic's lien related back to Royal's date of contract with Loftstrom.
The trial court determined that the June mortgage and the October mortgage were separate and independent from each other. Consequently, the trial court held that State Bank could only foreclose on the October mortgage, because only the September note secured the October mortgage. The September note was not a renewal of the June mortgage. The court also determined that Royal was the general contractor for the project and Brickman's August contract related back to Royal's contract. Therefore, Brickman's contract had priority over State Bank because Royal's contract predated both of State Bank's mortgages. The Appellate Court reversed the trial court's decision that the two mortgages were separate and independent and held that the October mortgage was a renewal of the June mortgage and that the June mortgage was a valid lien on the property. However, the Appellate Court affirmed the trial court's decision that Brickman had priority over State Bank. Pursuant to 770 ILCS 60/21, subcontractors who provide materials and services for contractors will have a lien that relates back to the date of the contractor's contract. Although there was not a written contract between Royal and Lofstrom, there was evidence indicating that work had been performed on the premises as early as June 27, 1988.
A mechanic's lien will have priority over a previously recorded purchase money mortgage if the value of the property was enhanced by the material men's work on the property. A priority dispute arose between a mortgage lienholder and mechanic's lienholders in Lyons Savings v Gash Associates. Lyons Savings v Gash Associates, 279 Ill App 3d 742, 665 NE2d 326, 216 Ill Dec 266 (1st D 1996). The dispute concerned a building in Rosemont, Illinois that was owned and operated by Diversified Holding Corporation (DHC). The property was encumbered by four properly recorded mortgages before the mechanic's lienholders performed work on the property in 1985. The four mortgage holders foreclosed on the property and forced the sale in 1987. The mechanic's lienholders argued that they were entitled to a portion of the sale proceeds pursuant to 770 ILCS 60/16. The trial court analyzed the mechanic's lienholders' claims under the market value theory. Id at 745, 329, 269. The market value theory dictates that the market value of the property after the improvements should be reduced by the market value of the property before the improvements. The mechanics lienholders will have priority up to the amount of the difference between the market value pre- and post- improvements. The trial court held in favor of the mortgage lienholders because the mechanics lienholders did not prove that the value of the property increased as a result of their improvements.
However, the appellate court reversed the lower court's decision and applied the contract price theory rather than the market value theory. Id at 745, 330, 270. The contract price theory should be applied when the improvements to the property are so small that the market value theory would not be applicable. In this case the cost of the improvements to the property was less than ten percent of the amount of the mortgages on the property. The contract price theory has 4 elements: "(1) the work in question was properly authorized by the owner of the property, (2) the contract price was reasonable for the work done, (3) the lien claimants complied with the terms of the contract, (4) the work constitutes a valuable and permanent improvement to the property." When the contract price theory is applied, the mechanics lienholders will have priority up to the amount of the contract price. The appellate court found that all four elements had been satisfied in Lyons Savings and held that the mechanic's lienholders had priority over the mortgage lienholders. Id at 748, 332, 272.
Purchase money mortgages have super priority status above prior recorded judgment liens against the borrower and subsequent liens on real estate property, except for mechanic's liens in some cases. A purchase money mortgage will be successfully created if the borrower used funds supplied by the lender to purchase the property and the executions of the deed and mortgage were part of the same transaction. The executions of the deed and mortgage do not have to occur at the same instant; however, a significant gap in time between the executions of the deed and mortgage may eliminate the creation of the purchase money mortgage. Lenders should also be aware that the super priority status of a purchase money mortgage can be lost if the mortgage is not recorded in a timely manner or recorded incorrectly.
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