A subsisting loan is not a reason to walk away. It is one of the more manageable defects in a title, and in Bengaluru it is present in a large share of resale transactions. What turns it into a disaster is sequencing, and specifically paying the seller first.
The search almost nobody runs
Chapter IV of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 set up a Central Registry. Section 23 requires the particulars of every transaction creating a security interest to be filed with the Central Registrar. Section 26 says the particulars entered in the Central Register are open during business hours for inspection by any person on payment of the prescribed fee, including through electronic media. So a buyer can look, and the consequence of not looking is severe.
Section 26C(1) provides that registration of the creation, modification or satisfaction of a security interest shall be deemed to constitute a public notice from the date and time of filing. Section 26C(2) then says the registered creditor's claim has priority over any subsequent security interest and that any subsequent transfer by way of sale, lease, assignment or licence of the property is subject to that claim. Read together, they mean that a purchaser who never searched the register still bought subject to what was on it. Section 26D adds that a secured creditor cannot enforce under the Act unless the security interest is registered, so the register is where a serious lender's charge will be.
What the seller owes you as a matter of law
Section 55 of the Transfer of Property Act, 1882 does a great deal of work here, in the absence of a contract to the contrary. Sub-section (1)(a) obliges the seller to disclose any material defect in the property or in his title of which he is aware and the buyer is not, and which the buyer could not with ordinary care discover. Sub-section (1)(b) obliges him to produce all documents of title in his possession for examination. Sub-section (1)(g) obliges him to pay public charges and rent accrued due up to the date of the sale, the interest on all encumbrances due on that date, and, except where the property is sold subject to encumbrances, to discharge all encumbrances on the property then existing. Sub-section (3) obliges him, once the whole purchase money has been paid, to deliver all documents of title in his possession or power.
The provision that lets you protect yourself is in sub-section (5)(b). Where the property is sold free from encumbrances, the buyer may retain out of the purchase money the amount of any encumbrance existing at the date of the sale, and shall pay the amount so retained to the persons entitled to it. That is your statutory authority for routing part of the price straight to the lender rather than to the seller, and it is worth quoting in the agreement.
What discharge actually looks like
Section 60 of the same Act tells you what to demand. On payment or tender of the mortgage money the mortgagor is entitled to require the mortgagee to deliver the mortgage deed and all documents relating to the property in the mortgagee's possession, to deliver possession where the mortgagee holds it, and, where the mortgage was effected by a registered instrument, to execute and have registered an acknowledgement in writing that the right transferred to the mortgagee has been extinguished. Separately, Section 25(1) of the 2002 Act requires the secured creditor to intimate payment or satisfaction in full to the Central Registrar within thirty days, and Section 25(1A) requires a memorandum of satisfaction to be entered in the Central Register on that intimation.
The closing sequence
- A foreclosure or outstanding statement from the lender, addressed and dated, with a validity date
- An Encumbrance Certificate for the full period, obtained yourself and not accepted from the seller
- A search of the central registry of security interests, since a deposit of title deeds may not show in the Certificate
- Confirmation of who holds the original title deeds, and physical inspection of them at the lender's counter
- Payment of the outstanding directly to the loan account, never to the seller
- The no dues letter, the release or reconveyance, and the return of the originals with a list
- The memorandum of satisfaction on the central register, checked afterwards rather than assumed
- A fresh Encumbrance Certificate taken after registration, to confirm the release has been recorded
The failure I see most often is a buyer who takes the seller's word that the loan was closed years ago, sees nothing in the Encumbrance Certificate, and completes. The mortgage was by deposit of title deeds, so there was nothing in the Certificate to see, and the originals were still with the bank. How to read the Certificate itself is set out in the encumbrance certificate answer and in our note on viewing it online in Karnataka. The different forms a mortgage can take are set out in our guide to mortgages under the Transfer of Property Act.