Alienation Clauses: What You Need To Know
If you have a mortgage, it almost certainly contains an alienation clause or some variation thereof. This clause requires you to repay your mortgage balance in full before transferring ownership of the property. Essentially, it means that if you sell your home you must repay the balance in full, usually with the proceeds from the sale.
What Is An Alienation Clause?
An alienation clause – also known as a due-on-sale clause – is language in the promissory note you signed when you took out your mortgage that requires you to pay in full the balance and accrued interest before transferring ownership of the property.
Another way to think of it is if the borrower decides to sell their home, the alienation clause spells out how and when they’re free of their responsibilities to the lender.
Alienation clauses are universal in today’s real estate market. If you happen upon a mortgage agreement without an alienation clause, you have an assumable mortgage, which allows a new owner, regardless of their credit score, to start paying the mortgage where the previous owner left off.
It’s important to know that an alienation clause doesn’t always have to be triggered whenever someone tries to assume a loan. To assume a mortgage with an alienation or due-on-sale clause, it has to meet the policies of the servicer of the loan and the mortgage investor who bought the loan from your original lender. If the loan was never sold, the lender’s policies apply.
Exceptions To The Alienation Clause
Alienation clauses became popular as interest rates rose to historic highs in the 1970s. In 1982, Congress passed the Garn-St. Germain Depository Institutions Act, which allowed lenders to enforce alienation clauses, with some exceptions.
Although lenders aren’t required to enforce an alienation clause, they are prohibited from enforcing it under the following conditions.
- Divorce: A separation or divorce that results in the borrower’s spouse becoming the sole property owner typically doesn’t trigger the alienation clause.
- Transfer to a living trust: Lenders are prohibited from enacting the alienation clause if the borrower transfers the property to a living trust where they are the beneficiary and occupant.
- Death: Your lender can’t enforce the clause if the borrower dies and the deed is transferred to or inherited by a spouse, child or relative who already lives or plans to live in the home.
- Assumable mortgage: If the loan agreement lacks an alienation clause, the new owner isn’t required to pay off the mortgage. This is an assumable mortgage.
- Second mortgage: It is illegal for the primary mortgage lender to demand a release of liability if a borrower takes out a second mortgage.
How Alienation Clauses Work
If you’re selling your property and have a balance on your mortgage, you’ll need to notify your lender and satisfy the alienation clause. There are at least two ways to do so:
- The buyer can pay your mortgage balance with their own financing.
- Your mortgage company could offer a mortgage to the new buyer under updated terms.
Regardless, your mortgage company could take legal action against you if the buyer doesn’t fulfill the alienation clause.
If you sell your property without notifying your lender, the mortgage company may open an account for the new buyer. The lender will evaluate the new buyer’s credit history, debt-to-income ratio, the home’s fair market value and several other factors before extending a new mortgage with current interest rates. The lender will often handle the funds transfer to pay off the seller’s debt, close their account, and return the profit.
Alienation clauses are typically short and sweet. Be sure that the language clarifies that the amount due at sale will be the outstanding amount and nothing more. Borrowers are expected to pay the remaining balance and any late interest fees they’ve accrued but never the interest that would’ve accrued over the life of the loan.
Alienation Clause Vs. Acceleration Clause
Acceleration clauses are similar to alienation clauses in they both allow lenders to demand full, immediate repayment of debt at their discretion. The acceleration clause, however, enables lenders to begin foreclosure, typically after a borrower misses at least two payments.
Less often, loan acceleration can be triggered by cancellation of homeowners insurance, failure to pay property taxes, a bankruptcy filing, or unauthorized transfer of property ownership.
FAQ
Here are answers to common questions about the alienation clause.
– The lender offers to work directly with the buyer to finance the remaining balance on the home and have the buyer take over your mortgage under updated terms and likely a different interest rate.
– The buyer secures their own financing through a lender and facilitates the full payment to your mortgage company.
The Bottom Line
The alienation clause is a standard provision in nearly every mortgage contract. While the clause is meant to protect lenders, it’s also important for home buyers to understand these provisions to protect themselves.
