In the ever-evolving world of mortgage lending, a scenario often arises where a borrower refinances their existing mortgage with a new lender, but the payoff funds tendered by the new lender are less than the full amount necessary to satisfy the existing lender’s mortgage loan. This situation raises crucial questions for lenders: How should short payoff funds be handled? Should the existing lender return these funds, apply them to the loan balance, or hold them in suspense? And what are the lender’s legal duties and obligations under New Jersey law?

Recently, a New Jersey appellate court affirmed a trial court’s ruling that discharged an existing mortgagee’s first mortgage lien of record after the mortgagee’s predecessor in interest returned loan payoff funds that were short by $30.53 to a refinancing lender’s title company and the funds were misappropriated. In U.S. Bank Trust N.A. v. Bronx Girls Flips, LLC (2025), the existing mortgagee’s predecessor in interest received a loan payoff that was allegedly short and it held the funds for a period of 14 days before returning them to the refinancing lender’s title company. The existing mortgagee failed to discover the defalcation of the funds until approximately one and a half years later.

The appellate court rejected the existing mortgagee’s argument, as appellant, that it was required to return the short loan payoff funds because the loan was accelerated and the full balance was due and owing. In concluding the existing mortgagee should have applied the funds and then pursued the remaining balance, the appellate court cited to the plain language of the mortgage which compelled the mortgagors to “pay when due the principal of, and interest on, the debtor evidenced by the note…” The court also cited equitable principles in concluding that the original mortgage should be discharged of record since the original mortgagee was in the best position to avoid the loss and prevent the defalcation.

Some of the takeaways from the Bronx Girls Flips which should guide lenders and servicers:

• Do Not Return the Funds! – unless the applicable loan documents expressly require the existing lender to reject and return short loan payoff funds, the existing lender should never return short loan payoff funds to a refinancing lender;
• The Loan Documents Control but Lenders Should Either Apply the Funds or Hold Them in Suspense – the terms of the parties’ contract always govern the lender’s obligations with respect to the handling and processing of loan payments. However, in some cases, the terms of the parties’ contract and/or their contractual duties and obligations may not be clear. Generally, lenders should accept and apply all payments to the loan balance or, in the alternative, hold the funds in a suspense or escrow account until such time as the remaining balance is paid;
• Refuse to Discharge Your Mortgage Lien Until the Balance is Paid – the existing lender has significant leverage in this situation, particularly if there is a title company insuring the refinancing lender’s mortgage as a first lien, since the existing lender can refuse to discharge its mortgage lien until such time as it receives payment of the deficiency balance owed;
• Communicate – the Appellate Court was very critical of the original lender’s failure to write to the borrower, the refinancing lender, and/or the title company’s escrow agent to inform them of the deficiency with the loan payoff and/or that the funds were being returned. Instead, the original lender never followed up to determine if the returned funds reached the correct party and/or whether new funds in the correct amount were being sent.

For mortgage lenders and servicers, the Bronx Girls Flips case highlights the importance of lenders and servicers having a common sense approach and clearly delineated policies and procedures for handling and processing short payoff funds. Ensuring you know how to handle and process loan payoff funds, apply them correctly, or hold them in suspense, could mean the difference between compliance and costly legal issues. By understanding your legal duties and implementing best practices, you can protect your institution from unnecessary risks, safeguard your borrowers, and stay ahead of regulatory requirements.