Key Takeaways

  • Novation Overview: A novation involves replacing an existing contract or obligation with a new one, transferring both rights and responsibilities from the original party to a new one.
  • Mortgage Novation: In real estate, novation can transfer a mortgage from one party to another, fully relieving the original party of all obligations.
  • Novation vs. Assignment: Unlike an assignment, where the original party remains liable, novation shifts both the rights and liabilities to the new party, often requiring approval from all involved parties.
  • Novation Process: Lenders typically require background checks and formal approval before novating a mortgage, making it a more formal process than simpler assumptions.
  • Common Novation Scenarios: Novation is often used in real estate transactions when renegotiating home prices, transferring leases, or changing earnest money deposits.

A deed of novation can be used to transfer the responsibility of paying off a mortgage loan to another person.

What Are Deeds of Novation?

When real property is sold, purchased, or transferred, a title and a deed will be used. To buy real property, many people choose to use a mortgage loan, which the person would then be legally obligated to repay. If you want to transfer this obligation to another person, you would need to use a deed of novation.

Deeds of novation can be used when one person wants to transfer their contractual obligations and rights to another party without having to alter the original contract. With a deed of novation, the person that wishes to leave a contract will be absolved of their responsibilities because the incoming party is assuming these duties. From the perspective of the other person in the contract, nothing has been changed. However, this remaining party will need to agree to the transfer before it can occur.

You can transfer mortgage obligations to either a third party or a completely new borrower by using a deed of novation. Once the formal novation has been approved, you will no longer be responsible for your loan.

Before using a deed of novation, there are several factors that you need to consider:

  • Does the contract include language allowing parties to transfer their rights and responsibilities?
  • Is approval from the remaining party required before novation?
  • Is there a provision preventing the remaining party from unreasonably withholding their approval?
  • Does terminating the original contract and entering a new contract make more sense from a commercial standpoint?
  • Will you or the new borrower be responsible for a default that takes place before the transfer occurs?
  • Will you use a pre-arranged date for the novation effective date or will the date of agreement suffice?

Mortgage Novation and Its Legal Implications

A novation can be used in the context of mortgages, allowing the original borrower to transfer the responsibility of repaying the mortgage to another party. This is typically done with the consent of the lender, as they must assess the financial qualifications of the new borrower. Once the novation process is complete, the original borrower is fully released from any future liability concerning the mortgage.

It’s important to note that mortgage novation differs from other types of loan assumptions. While some loan assumptions simply transfer the payments to a new party, novation entirely replaces the original contract. This process is often used in real estate transactions when a buyer takes over an existing mortgage under new terms. Mortgage novation can help buyers avoid initiating a new loan, potentially securing better terms than they might receive with a new mortgage.

Novation Parties

It's possible you won't receive approval to novate your mortgage responsibilities to a third party. When attempting to novate a mortgage loan, you, the third party, and the lender must agree to transfer the obligations. In most cases, lenders deny requests to novate loan responsibilities. If a lender does approve the request, they will usually have their own process for reviewing and approving the novation.

Lender Involvement in Mortgage Novation

Lenders play a crucial role in mortgage novation. Their approval is required to transfer the loan obligations from the original borrower to the new borrower. This process typically involves a thorough financial review of the new borrower, ensuring they meet the lender’s qualifications. If the lender agrees to the novation, the new borrower steps into the shoes of the original borrower, assuming full responsibility for the mortgage, and the original borrower is relieved of any future obligations. This ensures that both parties are protected and that the terms of the mortgage are maintained.

Are Assignments and Novation Different?

There is a big difference between an assignment and a novation. With an assignment, the original person in the contract retains their liability. With a novation, all liability is assumed by the new party to the contract. Assignments are used to transfer only rights; novation transfers both liability and rights. 

Three-party consent is required for novation, the new party, the outgoing party, and the remaining party must all agree to the transfer. The approval of the remaining party may not be required for assignment depending on how the contract is worded.

Mortgage Assumption vs. Mortgage Novation

While both mortgage assumption and mortgage novation involve transferring the mortgage to another party, they differ significantly in terms of legal responsibilities. In a mortgage assumption, the original borrower may still be held liable for the loan, while in novation, all liabilities are transferred to the new borrower. The lender’s approval is typically required for both processes, but novation provides a clean break for the original borrower, unlike assumption where they may still be tied to the loan if the new borrower defaults. This makes novation a preferable option for those looking to completely remove themselves from the mortgage obligation.

Deeds of Novation and Your Business

When a business person wants to exit an agreement or contract, it may be possible for them to find a new person to assume their obligations. Many businesses choose to use deeds of novation because they are much simpler than ending one contract and forming a new one.

There are countless reasons that a business might use a deed of novation. As mentioned, the primary reason business people use novation is to exit a contract. A deed of novation will allow the businessperson to leave the contract by transferring their responsibilities to a new party.

Another reason business people use deeds of novation is the need to transfer contracts after selling their business. For example, let's assume that you own a small market that regularly supplies fresh produce to offices in your area. If you sell your market to another person, you would also need to transfer your contracts with the offices so that the new owner can continue the produce deliveries.

With a deed of novation, the new owner of your business is accepting the responsibilities of the contracts to which you were once a party. From the standpoint of the offices receiving the deliveries, the contract remains the same. The only difference is that a new person is now responsible for upholding the terms of the contract.

Using Novation for Real Estate Investment

Novation can also play a significant role in real estate investments, especially when dealing with property portfolios. For instance, an investor may wish to novate the mortgages associated with a property when selling to another investor. By doing so, the original investor can avoid the financial strain of paying off the loan early while transferring the responsibility to the new owner. This process allows for smoother transitions in property sales and can offer a viable alternative to refinancing.

Frequently Asked Questions

  1. What is mortgage novation?
    Mortgage novation is the process of transferring the responsibility of repaying a mortgage from the original borrower to a new one, with the lender’s approval.
  2. How does novation differ from mortgage assumption?
    Novation completely replaces the original mortgage agreement, transferring both rights and liabilities to the new borrower, while assumption only transfers payments, not liabilities.
  3. Do I need lender approval for mortgage novation?
    Yes, lender approval is necessary as they must assess the financial qualifications of the new borrower before agreeing to the novation.
  4. When is mortgage novation used?
    It is commonly used in real estate transactions, especially when the buyer assumes the mortgage as part of the purchase of the property.
  5. Can novation be used for business property sales?
    Yes, novation can be used to transfer mortgage obligations when selling business property to another party.

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