The typical loan used to finance the purchase of a home is secured by a mortgage. If the homeowner defaults in the repayment of the loan, the lender can foreclose the mortgage and ultimately secure a judicial sale of the property. If the property is subject to a second mortgage, say for a home equity line of credit, that lender will only get paid if any proceeds from the sale are left over after the debt to the holder of the first mortgage is fully satisfied. Priority of mortgages is generally based upon the date of recording according to the maxim “First in time, first in right.”
If the homeowner later refinances the purchase money mortgage, the new lender will naturally want to be in first position. If there is a home equity mortgage, the new lender will require that it either be satisfied and discharged or subordinated to the lien of the new mortgage. It sometimes happens that although the balance of the home equity loan in brought down to zero, the mortgage itself is not discharged and the lender advances additional funds secured by that mortgage, which is now in front of the mortgage held by the new “first mortgage” lender.
The home equity lender’s first position is a bit of a windfall because that lender would have known it would be junior to the existing purchase money mortgage. In the event of a foreclosure of the refinanced mortgage, the court may mitigate the strict priority of the home equity mortgage’s first position under a doctrine known as “equitable subrogation,” under which the refinancing lender is entitled to the first position of the mortgage that was satisfied, but only for the amount actually advanced to satisfy the first mortgage. The home equity lender is in close to the position it would have been had the refinancing never taken place.
One limitation that has long been placed upon the tool of equitable subrogation is the disqualification of a new lender that has actual knowledge of the prior encumbrance. In a recent published case, however, the Appellate Division rejected that approach and instead adopted the rule articulated in the Restatement (Third) of Property: Mortgage subrogation is available even if the new lender has actual knowledge of the intervening lien, so long as the new lender reasonably expected to have priority equal to the mortgage being satisfied. The new limiting factor is whether the intervening mortgagee would suffer material prejudice. “Equitable subrogation is appropriate when loan proceeds from refinancing satisfies the first mortgage, the second mortgage is paid in full as part of the transaction, and the transaction is based on a discharge of the second mortgage, so long as the junior lienor. . . is not materially prejudiced.” New York Mortgage Trust 2005-3 Mortgage Backed Notes, U.S. Bank as Trustee v. Deely, ___ N.J. Super. ___, ___ (App. Div. 2021) (slip op. at 15).