Mortgage Modification – Is Consent Of Juniors Required?

With mortgage modifications ever more prevalent, both prior to and during the foreclosure process, the question asked ever more frequently by lenders and servicers is, do we need the consent of subordinate lienholders (particularly junior mortgagees) to the modification?  The actual concern behind that inquiry is the fear that a mortgage modification might somehow prejudice a junior party and lead to a reversal of priorities, that is, rendering the once senior modified mortgage as inferior.

A recent case in bankruptcy court sums up the law neatly and examines an enlightening example, reaching the succinct conclusion that there is no basis to subordinate a senior mortgage where the modification neither increased the principal amount nor the interest rate.  [Sperry Associates Fed. Credit Union v. U.S. Bank. N.A., 514 B.R.365 (E.D.N.Y. 2014).]

Here immediately are the key principles presented in the case, to be followed by a discussion of the modification to give a sense of the application of those maxims:

• A senior lender is free to enter into a modification agreement with a borrower without obtaining the consent of any junior lienors.
• But, if the modification prejudices the rights of a junior lienholder, or impairs its security, and has been made without that junior lienholder’s consent, the senior lienholder can lose its priority whereby the junior lienholder is elevated to a position of superiority.
• Where the modification prejudices the junior lienholder, but does not substantially impair the junior’s security interest or destroy the equity, then the senior lienholder will be required to relinquish to the junior its priority as to the modified terms only.
• The main factors considered are whether the modification increased the interest rate or the principal amount of the mortgage obligation.
• Extension of the time of payment does not in and of itself prejudice a junior lienor to require their consent.
• Changing the interest rate on the loan and securing that with the lien of the mortgage does work prejudice because the change increases the total amount of indebtedness placed prior to the subordinate lien.

In the reported case under discussion, the senior mortgage holder modified the loan pursuant to HAMP, the agreement lowering the borrower’s monthly payments due per the note.  Here is precisely what the modification did, it:

1. extended the maturity date of the note by one month; and
2. capitalized arrears on the note; and
3. deferred, without interest, any payment on account of a portion of the modified principal balance to the end of the term of the note; and
4. at the end of the term the deferred principal amount plus all other sums due under the note would be due and payable; and
5. reduced the interest rate for 5 years with periodic increases over the balance of the term, but never exceeding the original interest rate.

The attack from the junior mortgagee claiming prejudice was that by deferring principal to the maturity date, instead of providing for the amount to be amortized during the term of the note, the obligation became more susceptible to defaults at maturity.  In addition, it claimed that the modification adversely affected the junior mortgage prior to maturity because had there been a default and a foreclosure sale, the deferred balloon payment and reduced monthly payments under the senior mortgage would result in a higher amount due at the time of the foreclosure, thus reducing the proceeds of the foreclosure sale to satisfy the junior obligation.

The court disagreed with these claims of prejudice finding that the interest rate of the senior mortgage was substantially lowered, observing that the deferred principal amount due at maturity did not bear interest.  Accordingly, the total amount payable by the borrower on the senior mortgage was reduced by the modification.  Although the maturity of that mortgage was extended for a month, the accrual of additional interest for that short period did not offset the savings resulting from the reductions in the interest rate over the long term of the mortgage.

Next, the junior’s argument ignored the actuality that at the time of the modification, the borrower was in default under the senior mortgage.  So, rather than foreclosing that mortgage at the time, the borrower’s payments were reduced, thus improving the borrower’s ability to make on-going payments due under the junior mortgage.

Finally, the argument that deferral of principal under the senior mortgage to maturity increased the chance that the borrower would be unable to pay the junior mortgage at maturity did not take into account the actuality that the junior mortgage matured many years before the senior.  Thus, from the viewpoint of the borrower’s ability to pay the junior mortgage during its term and at maturity, the deferral of principal improved the junior’s position.

With these not unusual guidelines in mind, and knowing the principles of the law, lenders and servicers should be in a position to confidently proceed with modifications without necessity of obtaining the consent of junior lienors.  Of course, if for some reason the nature of the modification would visit prejudice on junior encumbrancers, then their consent will be required.

Mr. Bergman, author of the four-volume treatise, Bergman on New York Mortgage Foreclosures, LexisNexis Matthew Bender (rev. 2017), is a partner with Berkman, Henoch, Peterson, Peddy & Fenchel, P.C. in Garden City, New York. He is also a member of the USFN, The American College of Real Estate Lawyers, The American College of Mortgage Attorneys, an adviser to the New York Times on foreclosure issues and writes a regular servicing column for the New York Law Journal. He is AV rated by Martindale-Hubbell, his biography appears in Who’s Who In American Law and he has been for years listed in Best Lawyers In America and New York Super Lawyers.