Under a typical loan agreement, the lender provides cash to the borrower in exchange for a promise to pay the funds back with interest. The lender will typically also require some form of collateral as security for the promise to pay (i.e. if the borrower defaults on their obligation to pay, the lender gets to keep the collateral).
Most of the time the collateral is real estate encumbered by a lien of mortgage. It is also possible to pledge payments the borrower receives from a third party as collateral for their own loan. This becomes more clear in an example.
Collateral Assignment Example
John owns Lot 1. After purchasing the property, John borrows money from WP Investment Company and gives them a mortgage (lien on the real property) on Lot 1. This leaves WP Investment Co. with a security/asset/stream of payments coming in from John via the “Promissory Note” and lien of “Mortgage”. Let’s call John the “Original Borrower” and WP Investment Co. the “Original Lender”.
WP Investment Company owns Lot 72 – a risky commercial property. WP Investment Company is looking to borrow money from Bank of New York. The Bank is willing to loan WP money, but requires some additional security to compensate for the riskiness of the property. WP discloses that they have payments coming in from John (via the mortgage on Lot 1), and they’d be willing to pledge this to the Bank as additional security/collateral for the loan. Among other titles, WP would be known as the “Collateral Assignor” and Bank of New York would be both the “Collateral Assignee” and the “Collateral Lender”.
Keys to a Collateral Assignment
It is important to note that the Mortgage is not assigned to the Collateral Lender (it’s not an Assignment of Mortgage). Rather, the promissory note is what is assigned to the Collateral Lender (and should be physically delivered/possessed by them). This means that the loan is basically split in two, with the interest in the real property (Mortgage) remaining with the Original Lender and the personal property interest (Promissory Note) transferred to the Collateral Lender. Despite this (and as detailed below), satisfying and foreclosing the mortgage should be handled by both parties – as they both have interests in the underlying loan.
How to Satisfy a Collaterally Assigned Mortgage
There are two options when seeking to release a mortgage that has been subsequently collaterally assigned:
- Get a satisfaction of mortgage from both the Collateral Assignor and the Collateral Assignee. Both have an interest in the mortgage being satisfied, therefore, both are required to release it.
- Get a Collateral Assignment from the Collateral Assignee back to the Collateral Assignor (from Bank of New York back to WP Investment Co., in the above example). Then get the Satisfaction of Mortgage only from the original lender/Collateral Assignor (WP Investment Co, in the above example).
There are two foreclose scenarios to consider: 1) A default of the Original Borrower, or 2) A default of the Collateral Assignor.
A default of the Original Borrower will require both the Original Lender and the Collateral Lender/Assignee as co-plaintiffs to the foreclose proceedings. The property would then be either co-owned or divided pursuant to their interests in the real/personal property. Alternatively, the Collateral Lender could assign their interest back to the Original Lender – with the Original Lender then foreclosing out the property.
A default of the Collateral Assignor will not substantively affect the Mortgage. The Collateral Lender would be able to pursue its rights under the promissory note (under the Uniform Commercial Code, as the UCC governs personal property), possibly taking over the Original Lender’s interest in the Mortgage. This would leave the Mortgage still intact.
Insuring a Collateral Assignment of Mortgage
While the Collateral Lender/Collateral Assignee was not assigned the Mortgage, they do have an interest in it (as they hold the promissory note/obligation secured by the Mortgage). Therefore, the loan policy insuring the Mortgage may be endorsed or a new loan policy may be issued altogether. Most underwriters will allow either of the following:
- The Collateral Assignee to be listed as the only party insured. This would also require an exception for any rights the Collateral Assignor may have in the underlying mortgage.
- Both the Collateral Assignee and Collateral Assignor to be listed as the insured parties.
Collateral Assignment of Mortgage Form
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Collateral Assignment of Mortgage or Deed of TrustRevised: 10/1999AUTHOR: David DickardDEFINITIONA collateral assignment of a Mortgage or Deed of Trust is primarily a personal property right, i.e., the rights to the underlying Note itself given to the assignee, but the collateral assignment can be insured if certain steps are followed.One way to look at a collateral assignment is that the Note and Deed of Trust now have two beneficiaries, both of whom must be dealt with if the Deed of Trustis to be foreclosed, released, or reconveyed. When a Note and Deed of Trust arecreated, they become a receivable, or asset, in the hands of the lender. If thelender itself subsequently decides to raise cash, they can sell the asset to another investor and assign the Note and Deed of Trust outright to that investor. Sometimes the original lender decides instead to raise cash by borrowing money from another lender. As part of that transaction, they can pledge that asset as security or collateral for the loan they are receiving. The collateral assignmentis the document that is recorded to show that the original lender used the assetas security to borrow money, rather than selling the asset outright to a new investor.RELATED TOPICS DETAILED EXPLANATIONPERSONAL VERSUS REAL PROPERTYThe holder of a Collateral Assignment does not own an estate in real property. This is because the collateral they hold is the promissory note itself, as opposed to the lien against real property created by the Deed of Trust. Default by theoriginal lender on the collateral loan does not directly entitle the collateralassignee to foreclose on the Deed of Trust. This makes sense if you consider that the property owner should not be vulnerable to losing their property to foreclosure unless the property owner itself has defaulted on the original Note and Deed of Trust. By law, a promissory note is personal property, which is governedby the provisions of the Uniform Commercial Code. If the original lender defaults on the collateral loan but the property owner has not defaulted on the original loan, the collateral assignee must assert its rights to the original promissory note pursuant to the UCC. See related topics, Uniform Commercial Code.LENDER PRIORITYIt is common for both the original lender and the collateral lender to have simultaneous, proportionate rights to the original Note and Deed of Trust. One reason for this is that the collateral loan is often for less money than the originalloan. When this scenario occurs, the original lender will not want to assign all of its rights to the original security to the collateral lender. Accordingly,anyone dealing with a Deed of Trust that has been collaterally assigned should presume that both lenders have rights to that security. If a collaterally assigned Deed of Trust is being paid off, either both lenders should sign the release or the collateral lender should reassign its rights back to the original lender.If the property owner has defaulted on the original Note and Deed of Trust and aforeclosure is looming, the foreclosure should be conducted on behalf of both lenders and the foreclosure proceeds should be distributed according to their proportionate interests in the original Note and Deed of Trust. As will be discusse