A borrower that retains any amount of money to finance a property purchase or refinance in return for giving the lender security interest in the property is a mortgage. Mortgage payments are made, typically on a monthly payment schedule to keep current with the conditions of the mortgage. Should the borrower not keep current with payments or property taxes, the lender or the government, depending on the type of debt that is due, has the right to initiate a foreclosure to recover the property to collect the money they are owed.
Lien theory is the financial concept that the title of a property is in the name of the borrower even though the borrower has a loan on the property, which is oftentimes higher than the amount of equity they have. In other words, the borrower is the exclusive owner of the property, irrespective of whether a lender has helped fund the purchase or refinance unless the borrower has a foreclosure at which point the lender or government would have full possession of the property.
Lien Theory vs. Title Theory
Lien theory is a major concept in real property. The concept states that the title of the property is the property owner’s until or unless a foreclosure were to occur. This means the deed is in the name of the property owner. Upon getting a mortgage, the lender can place a lien on the property to state their rightful interest in the property. The lien can be filed against the property by submitting a lien with the county recorder’s office.
The lien indicates that the lender has a security interest in the property in the form of a mortgage that was used to secure the purchase or refinance. Until the lien is paid off, the lender holds an interest in the loan. Assuming the borrower wants to sell the property, the lender would have to get paid and therefore their security interest in the property terminates upon the consummation of the sale.
Title theory on the other is much different than lien theory. In title theory, the title of the property is in the name of the lender, rather than stay in the name of the borrower which is the case in lien theory. Most states do not use title theory, rather they use lien theory as the basis for their mortgages. In title theory, when a borrower gets a loan, they transfer the title to the lender until the borrower has paid back the full principal balance of the mortgage. If the loan is refinanced or sold to another lender, the new lender will hold title to the property.
Notes on Lien Theory
In California and many other states, a deed of trust is used rather than a mortgage. They both function with the same purpose, serving as proof that a borrower owes a lender money. After the loan is paid is paid in full or the loan is refinanced, the deed of trust will be fully conveyed to the property owner.