Who Owns Your Home—You, or the Bank? Check for a “Defeasance Clause”

Defeasance? What’s that?

Some home loans contain a defeasance clause. It means you’re giving up collateral. Do your home loan documents have defeasance language? If so, your lending institution holds your home’s title for as long as you owe the lender money.

Although the legal owner is your lender, you are still called the homeowner. Yet your title isn’t at home with your loan documents. Your lender will hold onto your title until after that final payoff.

Once you meet all of your loan obligations, including a full and final pay-off, you trigger the defeasance clause. That, in turn, unlocks the final phase of your agreement. That’s the conveyance of title from the lender to the successful owner of a paid-off home. The title will then be yours — free and clear.

Who Has One? It Depends on the State Your Home’s In

While a home loan is commonly called a mortgage, some states use regular mortgage agreements, and others use a deed of trust to secure a homeowner’s debt. So, is your home in a state with mortgage liens, or a state that prefers the deed of trust?

Here’s why the answer matters. Lenders in different states have distinct methods to claw back the asset that secures a loan if you don’t repay debt as agreed. There are two main types of foreclosure: judicial foreclosure and nonjudicial foreclosure.

Lien Theory States

Some states are lien theory states. In these states, a lender has a mortgage lien. Buying a home in one of these states? Your lender will record a lien on your home while you, the borrower, keep your title in a file at home. Your lender will never receive your home’s title. Instead, the lender will record a lien on the title.

So, a mortgage document is an agreement between just the two parties: lender, and buyer.

The way to clear your title of the mortgage lien, of course, is to pay it off. Quit paying, and your lender may take you to court to begin foreclosure on your title.

No one really likes to go to court. A lender would prefer to avoid it, given the rules and time it takes to go through a judicial foreclosure. But that’s the way it works if a mortgage lender wants to recover the value of its product: the loan debt.

Deed of Trust States

Now, let’s look at deeds of trust. These documents let the lender keep the title for you, in a trust. States with deeds of trust are called title theory states. (To remember this, you could think of the phrase It’s my title, in theory.)

A third-party trustee, such as an escrow company, stands in the middle, between you and your lender. With defeasance, your title remains in trust as loan collateral. You sign the deed of trust and it’s recorded, like a mortgage, at your home county’s deed recording office. At that point, you, the buyer, have only equitable title. Once you’ve finally paid your debt off, the trustee must formally release the real estate title to you.

Which kind of state are you in? Check our list of lien theory, title theory, and hybrid states on Deeds.com. Note: These provisions can vary, even in a given state. Rules can change — for example, when the states’ courts weigh in on their real estate laws. To be sure, check your own loan documents, or call and ask your mortgage company.

Now, imagine that you struggle to pay your loan back, and your account goes into default. Then, the trustee takes control of both your home and the loan. You get a final shot at making good on the loan. Otherwise, foreclosure happens, and your home goes through a trustee sale. The successful bidder gets a trustee’s deed. The trustee will use the proceeds to make the lender whole, if possible.

No bidders? Then the trustee’s deed will transfer the home itself — now unconditionally — to the lender.

Lenders Love Deeds of Trust

The deed of trust names the trustee — a service that holds conditional ownership through the duration of the loan. This makes foreclosure on behalf of the lender relatively easy. Non-judicial foreclosure means the lender simply receives the title from the escrow company.

With a regular mortgage, in contrast, the lender has to pull the borrower into court.

Of course, most homeowners with deeds of trust faithfully pay off their loans until that sweet final payoff, or until they sell. This brings us back to our starting point: defeasance. According to the Merriam-Webster Dictionary:

The meaning of defeasance is the termination of a property interest in accordance with stipulated conditions (as in a deed).

The conditional ownership held by the lender is over, once the homeowner has completed the debt payoff. On that fine day, the lender records a deed of reconveyance, giving the homeowner that long-awaited title, free and clear.

After full payoff for a deed of trust, the lender signs and notarizes a deed of reconveyance. In some states, this official proof of title transfer from lender to borrower is called a mortgage satisfaction. Reconveyance happens when the homeowner decides to sell or refinance the home, ending the loan to start a new one.

The lender has a time limit (three weeks after full payoff is common, but check your state’s law) to produce the deed of reconveyance and to end the role of the trustee. This is parallel to issuing a deed of release of a mortgage in a lien theory state. In either case, the homeowner has faithfully repaid the debt, and fulfilled all obligations under the terms of the loan.

Mix and Match? Some States Use a Hybrid Method

So now you know how defeasance in a deed of trust situation differs from release of a mortgage lien. But there are also those in-between states.

In some locations, for example, a homeowner holds the title, but a lender can take that title back for nonpayment without going to court. A mortgage with a power-of-sale clause is a sort of hybrid. It enables lenders to bypass judicial foreclosure to hold a trustee sale. Still, lenders using power-of-sale do need court orders that confirm the sale and protect the integrity of real estate titles.

Whether you live in a state that uses mortgage agreements or deeds of trust or something in between, state law controls the details. A debtor in default always gets a state-specified time to redeem the loan.

Buyers of distressed homes will need to know about these distinctions, too. If the court is involved, it might be many months before a new buyer can receive the title. In states that use deeds of trust scenarios, the conveyances can happen faster.

So, lenders like deeds of trust, and buyers do, too. Struggling borrowers? Well, they’d have a different view.

Supporting References

Bankrate via Bankrate.com: What Is a Defeasance Clause, and How Does It Work? (Feb. 24, 2023).

Deeds.com: What Is a Deed of Trust? (Jun. 17, 2019).

Deeds.com: You’ve Paid Off the Mortgage. What Happens Now? (Apr. 4, 2019).

And as linked.