Finally, there are special types of loans/mortgages called "purchase money mortgages”.
The mortgages occur when the money lent to a mortgagee is used for the purchase of
the item itself. This typically occurs with owner financing -- if a homeowner sells her
home and loans money to the purchaser to buy it, there is a purchase money mortgage
in the house. These types of mortgages will take priority, even if there is a primary
lender that attached prior to the purchase money mortgage being issued.
In this case, Ira purchased the machine shop from Jane for $500,000. Obviously Ira did
not have that cash up front. Instead, he paid $50,000 in cash to Jane, which is hers to
keep and is not up for grabs at the foreclosure sale. Next, he gave her a promissory
note for an additional $50,000 secured by a deed of trust. Then he borrowed another
$400,000 from Acme Bank, which recorded a mortgage.
If the $50,000 from Jane was secured by an interest in the machine shop, the very
property the loan was made to purchase, this loan will take priority and Jane will be
entitled to the first $50,000 received in the foreclosure sale.
Acme will argue that it is the primary lender and that it is entitled to all the money from
the foreclosure sale, until it exceeds its $400,000 loan, at which case it may spill over to
secondary lenders. There are two problems with this argument: 1) First, as discussed
above, Jane's loan to Ira was a purchase money mortgage and takes priority over the
Bank's loan. Even if it were not a purchase money mortgage, Jane was still the first
lender. 2) Second, Acme knew of Jane's promissory note and deed of trust prior to the
close of escrow. Notably, although Jane did not appear to record her mortgage, a
recording is not required to secure an interest. Rather, a recording system serves to
give subsequent mortgagees and purchasers notice, something Acme already had.
The issue then becomes, what is the effect of Acme's knowledge on its mortgage in the
property? Generally, in order to take priority, a mortgagee must be a holder in due
course, or a bona fide mortgagee, who takes without knowledge of any other interests in
the property. In this case, because Acme knew about Jane's deed of trust, Acme was