A mortgage is a lien upon real property which acts to secure the obligation under a promissory note. More simply, a borrower’s promise to pay back the loan is supported up by a “foreclosable” lien on their real property. If the borrower quits paying and therefore fails to meet their obligation under the promissory note, the lender may foreclose upon the mortgage and take ownership of the real property.
Throughout the life of the loan, circumstances may change and the borrower may want to amend its terms. This could include changes to increase or decrease the interest, extend the payback period or increase the amount borrowed. These changes have the potential to adversely affect the priority of the original mortgage and jeopardize the status of the loan policy. A modification adversely affecting the priority of the original mortgage is commonly referred to as a “novation”. When asked to insure a mortgage modification, it is necessary for the title agent or underwriter to determine if a novation will occur.
Novation and Triggering Substitution Rate
How do you determine if a novation occurs? Very generally, a novation occurs when additional burden (not contemplated by the original loan) is placed upon the borrower. For example, the original promissory note states that the interest rate is to remain fixed at 5%. If a mortgage modification increases the interest rate to 8% (causing the payment to increase as well), additional burden is placed on the borrower and a novation would typically occur.
From a title insurance standpoint, the lender will typically want their modification added as insured under their loan policy. If said modification causes a novation (the priority of the mortgage now becomes the date of the modification), the underwriter may be exposed to additional liability. Rather than having the lender pay for a new loan policy to account for this increased liability, the State of Florida under 69O-186.003(4) F.A.C. provided a discounted pricing structure known as Substitution Rate.
Now that you have a general overview, become an expert on the topic. Our comprehensive eBook (pdf) details:
- Novation vs Triggering Substition Rate
- How to review the documents
- How priority is affected by a mortgage modification
- Preparing the endorsement
- Frequently asked questions
- Spreader Agreement
- Template Blank Endorsement Form
Download our Mortgage Modifications: A Title Insurance Overview PDF eBook here: