Legal Mortgage vs Equitable Mortgage

A legal mortgage and an equitable mortgage are two types of security interests over property used in financing transactions, each with distinct legal characteristics, methods of creation, and implications for both the borrower and lender. Understanding the differences between these two forms of mortgages is essential, especially for those involved in property law or real estate transactions.

Legal Mortgage
A legal mortgage is the most secure and common form of mortgage. It is created by transferring the legal title of the property to the lender (mortgagee), with the understanding that the title will revert to the borrower (mortgagor) once the loan is fully repaid. Legal mortgages are governed by strict statutory requirements, particularly under the Law of Property Act 1925, which mandates that a legal mortgage must be created by deed. The lender holds a legal interest in the property, granting it strong rights, including the right to take possession of the property or sell it to recover the loan if the borrower defaults. These rights can usually be exercised without the need for a court order, although, in practice, court proceedings are often initiated to ensure fairness, particularly when the borrower resides in the property.

In terms of priority, legal mortgages take precedence over any equitable interests in the property. This means that in the event of insolvency or a sale of the property, the legal mortgage will be satisfied first before any claims based on equitable interests. Legal mortgages must be registered with the Land Registry to protect the lender’s interest fully. Failure to register the mortgage could result in the loss of priority to later registered interests, which can be highly problematic for the lender in a foreclosure or insolvency scenario. The vast majority of residential and commercial property loans, especially those granted by financial institutions, are legal mortgages because they offer greater protection and security.

Equitable Mortgage
An equitable mortgage arises in situations where the legal requirements for creating a legal mortgage are not fully complied with, but there is still a clear intention to create a security interest in the property. This could happen, for example, if the borrower deposits the title deeds of the property with the lender without executing a deed, or if there is an agreement to create a mortgage but the formalities are incomplete. As a result, the lender acquires only an equitable interest in the property, which provides less protection than a legal mortgage.

The rights of an equitable mortgagee are more limited. Unlike in the case of a legal mortgage, where the lender may have an immediate right to possession or sale, the equitable mortgagee usually needs to apply for a court order to enforce its rights, such as selling the property to recover the loan. In addition, an equitable mortgage ranks below any legal mortgages on the same property. This means that if the borrower grants a legal mortgage to another lender, the legal mortgagee’s interest will take priority, and the equitable mortgagee may be left with little to recover from the property sale proceeds. Nonetheless, an equitable mortgage is still enforceable and can provide valuable security to the lender, although it is less favorable than a legal mortgage.

In practice, lenders often prefer legal mortgages because they provide stronger rights, easier enforcement, and clear priority over other claims on the property. Equitable mortgages are more commonly seen in informal or urgent lending arrangements where it may not be possible to complete the necessary formalities to create a legal mortgage. For instance, an equitable mortgage may arise when someone agrees to mortgage their property but has not yet signed the deed, or when a borrower deposits the title deeds with the lender as an interim form of security until the formal legal mortgage can be executed.