Most anybody who works in real estate knows what a mortgage is.  Simply stated, a mortgage is a lien against property given by the property owner to a lender to secure the repayment of a loan made by the lender to the property owner.  Clearly, such a loan transaction is far different from a sales transaction, whereby the property owner, as the seller, conveys the title to their property to a buyer in exchange for cash.  There certainly then cannot be any confusion about whether a particular transaction, whereby a property owner received money, is a loan transaction or a sales transaction.  Or can there?

Say, for example, an owner is facing imminent foreclosure, and is unable, perhaps because of poor credit, to obtain a loan to pay off the foreclosing lender to stop the foreclosure.  The owner instead sells their property for sufficient money to pay off the lender, and upon transferring title to the buyer, enters into a lease to lease back the property from the new owner, along with an option to repurchase the property at some future date for a price in excess of the amount for which the property was sold.  Is it possible that such a transaction, which appears on its face to clearly be a sales transaction, is “really” a loan transaction?  Under the doctrine of “equitable mortgages,” the answer may surprisingly be “yes.”

Interestingly, whether or not a transaction is deemed to have created an equitable mortgage depends, in large measure, upon the subjective “intent” of the parties, regardless of whether such intent is consistent with the manner in which the transaction was documented. In other words, if the parties intended the transaction to be a loan, even though it is documented as a sale, it will be treated as an equitable mortgage loan.  The equitable mortgage doctrine was created to prevent unscrupulous lenders from disguising what was really a loan, as a sale and option, in order to avoid having to go through the foreclosure process in the event of default. If the “seller,” who is really a “disguised borrower,” defaults on the payment of their “rent,” which is “really” loan payments, then the lender, disguised as a “buyer,” who already holds legal title, can summarily terminate the tenancy and option rights of the “seller” without having to go through the foreclosure process, and can then proceed to deal with the property as they choose. 

The Arizona courts have identified certain factors that may establish that what appears to be a sales transaction was “really” a loan transaction.  Those factors include whether the parties had engaged in prior loan transactions; whether the seller was suffering financial distress; whether the amount paid by the buyer was substantially less than the actual value of the property at the time of the transaction; whether there was a contemporaneous agreement to allow the seller to repurchase the property, and if so, whether the repurchase price reflects the actual value of the property; and whether the subsequent acts of the parties following the consummation of the transaction was consistent with a lender-debtor relationship, rather than that of a seller and buyer.  If enough of these factors can be proven, and if the intent of the parties supports such a finding, then the court will find that despite the manner in which the “sales transaction” was documented, the transaction will be legally treated as a loan.

The doctrine of equitable mortgages is intended to, and undoubtedly does, serve as a deterrent to unscrupulous lenders; however, it may also create a trap for unwary buyers, who may end up being divested by a court of their rights as an owner, and treated instead as only a lender.