Loan novation is a legal process where one party transfers the responsibility of the loan agreement to someone else. The original obligations set forth in the loan agreement will remain the same, but the parties involved will change during the process and be revealed on a new contract. During the novation process, the original owner of the contact has the contract revised to reflect a change in the liability of the contract or to outline a new plan that still obliges the same terms, with a few possible minor changes.
There are three types of loan novation processes that can take place.
The first type of loan novation that can take place is where the responsibility is not assumed by someone new, but the original agreement is reconstructed into a new agreement. The new agreement will retain the same obligations, with some minor changes. This type of loan novation process is common in cases where a customer wants to take advantage of a new finance rate, interest rate, or plan that is being offered by the company.
The second type of loan novation happens when the original debtor of the contract wishes to transfer the liability of the contract to a new party, who will then become the new debtor on the contract. The original obligations will still be present, but the original debtor will no longer be liable for the loan under the new contract. This type of loan novation is very common in divorces where a mortgage is present.
The third kind of loan novation takes place when the original creditor wants to transfer the responsibility, of holding the contract, to a completely new creditor. The original contract is only amended to remove the original creditor and to name the new creditor. All original obligations and debtors remain the same. A case where this type of loan novation would be present is when a company is sold to another company.
Loan novation’s are a very common practice and can be found in several of circumstances. For example, a divorce where a mortgage is present would be a very common place where a loan novation would be needed. In a divorce the assumed responsibility of the mortgage is decided by the courts and if both parties are named on the mortgage, the party who did not assume the mortgage in the divorce will have to be removed. The loan novation process will remove the un-assumed parties name and draft a new contract to only reflect the responsibility of the assumed party.
A loan novation is only legal when all parties fully agree to the process. But the problem with most loan novation processes is that one party will not agree to assume full responsibility. This type of problem arises mainly in situations where property is involved. In the event of this happening, a quitclaim deed will need to be introduced in conjunction with the loan novation. A quit claim deed will allow the un-assumed party to completely eliminate their interest in the property, thereby, forcing the assumed party to take responsibility of the said property.
The main benefit of a loan novation is that it allows a party to erase their responsibility from a binding contract, given that all parties agree to the process. This is very advantageous when it comes to a divorce or separation where the assets are divided among each party. The liability attached to said assets can be transferred to the main party who will be assuming the sole responsibility for said assets.
‘Lectric Law Library (2010). Novation.
Mortgage Fit. (2010). Quit Claim Deed.
Wise Geek (2010). What is Novation?