Real Estate Financing and the Equitable Mortgage: How Equitable Mortgages Can Save Your Home or Kill the Deal of a Lifetime
Contrary to popular belief, the Arizona courts will rewrite your real estate contract and impose an equitable mortgage if they believe a deal is too unfair. “Let your yes be yes and your no be no” is not always the case when real property is involved. As such, both homeowners and investors should know what an equitable mortgage is, and how it can impact their particular circumstances.
Equitable Mortgages can both help or hurt investors and borrows alike.
Contracts for the outright sale of real property with a buy back option, sale of real property, and lease to own are most susceptible to creating an equitable mortgage. Instead of placing a lien on the real property, such contracts allow the lender to retain full title to the property. When drafted fairly, such contracts benefit both investors and borrowers. Investors gain access to a lucrative market that while being high risk, allows for even higher returns. High-risk borrowers benefit because they gain access to credit, even though they cannot otherwise qualify for a conventional loan. Lender-title loans can save the family farm from foreclosure or allow a first-time homebuyer a chance at home ownership.
While they can be a force for good, such loans can also be abused. Upon default, the lender keeps all the equity the borrower had or rather, would have had in their property, often worth hundreds of thousands of dollars. Because the forfeited equity is so valuable, the lender’s returns are equivalent to charging 20% or even 30% interest on their loans, potentially in violation of Arizona’s usury laws. In response, the Arizona courts created the equitable mortgage.[1]
Investors and borrowers must be cognizant of equitable mortgages because they determine who owns the equity in a property. If an equitable mortgage exists, the borrower retains the equity of redemption. Even if a contract characterizes mortgage payments as rent or interest, an equitable mortgage will rewrite the contract to protect the borrower’s equity. If there is no equitable mortgage, the lender keeps the equity as compensation for assuming greater risk.
An equitable mortgage is formed when a mortgagee and mortgagor intend to create indebtedness that persists after the transfer of real property.[2] They are governed by their substance, rather than their form.[3] As such, equitable mortgages must be proven from and in light of all the circumstances surrounding the transaction.[4] The debt does not need to be evidenced by a note,
bond, or other written material. Whether the debt preexisted the transaction or was created by the agreement is irrelevant. All that is required for an equitable mortgage is a bona fide debt.[5]
An Equitable Mortgage is formed when a mortgagee and mortgagor intend to create indebtedness that persists after the transfer of real property.
To determine if a contract is an equitable mortgage, Arizona courts utilize a six-factor test established in Merryweather v. Pendleton. The courts consider:
(1) The prior negotiations of the parties;
(2) The distress of the “grantor”;
(3) The fact that the amount advanced was about the amount that the grantor needed to pay an existing indebtedness;
(4) The amount of the consideration paid in comparison to the actual value of the property in question;
(5) A contemporaneous agreement to repurchase; and
(6) The subsequent acts of the parties, as a means of discerning the interpretation they themselves gave to the transaction.[6]
Even though the Merryweather test provides a framework for equitable mortgages, it is not exhaustive. The courts will also consider the sophistication of the parties to the transaction, and whether either of the parties are engaged in the business of loaning money.[7] They will give weight to whether the party characterizing the transaction as a sale ever inspected the premises, took possession of, occupied, or collected rents from the property.[8] Who paid property taxes on the property after the transaction also provides guidance.[9]
Every equitable mortgage case is unique and determined on a case-by-case basis. If you are concerned your real estate investment contract could be rewritten into a mortgage, or you have lost the equity in your house because of a missed payment, the attorneys at Provident Law® are ready to help you protect your investment. Contact the offices of Provident Law® today online or at (480) 388-3343.
David Korn is an Attorney at Provident Law. His practice areas include commercial and real estate litigation. He can be reached at David.Korn@ProvidentLawyers.com or at 480-388-3343.
- [1] Reese v. Rhodes, 3 Ariz. 235, 238 (1890).
- [2] Rogers v. Greer, 70 Ariz. 264, 268 (1950); Coffin v. Green, 21 Ariz. 54, 59 (1919) (“The principal test to be applied in determining whether a given instrument is a mortgage is whether the relation of the parties towards each other of debtor and creditor continued after the execution of the instrument.”).
- [3] Kennedy v. Morrow, 77 Ariz. 152, 268 P.2d 326 (1954).
- [4] Merryweather v. Pendleton, 90 Ariz. 219, 224 (1961).
- [5] Merryweather v. Pendleton, 90 Ariz. 219, 224 (1961).
- [6] Merryweather v. Pendleton, 91 Ariz. 334, 342 (1962).
- [7] Shelton v. Cunningham, 109 Ariz. 225, 228 (1973).
- [8] Downs v. Ziegler, 13 Ariz. App. 387, 477 P.2d 261 (1970).
- [9] Bostwick v. Jasin, 170 Ariz. 15, 17 (Ct. App. 1991) (The fact the mortgagee paid the property taxes on the land as opposed to the mortgagor was sufficient evidence to support the existence of an equitable mortgage).