What Is A Due-On-Sale Clause?
It used to be common for mortgages to be assumable by prospective buyers. But Congress passed the Garn St. Germain Depository Institution Act in 1982, which made due-on-sale clauses federally enforceable.
A due-on-sale clause is a provision in a loan or promissory note that enables lenders to demand the remaining balance of a mortgage loan be repaid in full if a property is sold or transferred. This clause protects lenders by preventing buyers from being able to assume a mortgage contract that has a below-market interest rate. However, transfers to spouses, children and trusts are some exceptions to due-on-sale clauses.
How Does A Due-On-Sale Clause Work?
Typically, when a property is purchased, the buyer will obtain a new mortgage to pay the seller for the house, and the seller will use those proceeds to pay off the remaining balance of their mortgage. This common practice exists in part because of due-on-sale clauses.
What Is An Alienation Clause?
To ensure sellers don’t transfer their mortgage to prospective buyers, lenders include a due-on-sale clause, also known as an alienation clause. This clause protects the lender’s security against the possibility that a buyer will assume a mortgage with a low interest rate or terms the buyer would otherwise be unqualified to obtain.
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When Do Mortgage Lenders Use A Due-On-Sale Clause?
The due-on-sale clause allows the lender to require immediate repayment of the mortgage balance when the mortgaged property is sold or transferred. Since a mortgage is a type of encumbrance or lien, lenders are automatically notified when a property that secures a loan is transferred.
Therefore, if a lender discovers that the borrower has attempted to transfer real property to a buyer without their consent, the lender can foreclose on the property.
How Do Lenders Determine When To Invoke A Due-On-Sale Clause?
While the due-on-sale clause is prevalent in contemporary mortgages, it’s up to the lender to determine whether the situation calls for the clause to be invoked. The lender is likely to do so if they:
- Feel their security is at risk in the hands of an unvetted buyer
- Believe they can make more money if the buyer applies for a new loan
However, the lender may be less likely to force the borrower to immediately pay off the mortgage in full if the market is weak and the lender is concerned they will not ultimately be able to recoup their costs by foreclosing on the property.
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Are There Exceptions To The Due-On-Sale Clause Law?
Despite the prevalence of due-on-sale clauses, certain legal exceptions negate lenders’ rights to demand the full payment of the mortgage. These exemptions include:
- Divorce or legal separation: If the borrower files for divorce or legal separation, the property may be transferred to the spouse or child of the marriage without invoking the due-on-sale clause. However, the new owner must occupy the property for this to be the case.
- Inheritance: If the borrower dies and a relative inherits and occupies the home, the relative can’t be forced to pay off the remaining mortgage balance on demand. However, if the heir chooses not to occupy the home, the transferred title can trigger the due-on-sale clause. This exception applies when the borrower transfers the property to a child or spouse.
- Living trusts: If the property is transferred into a living trust, as long as the borrower continues to occupy the property and remains the beneficiary of the trust, the lender can’t force the borrower to pay off the mortgage on demand.
- Joint tenancy: If the borrower entered a joint tenancy agreement when purchasing the house, a lender can’t enforce the due-on-sale clause if the borrower dies. Instead, the surviving joint tenant automatically assumes the entire mortgage and can pay it off as initially planned.
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What If I Live In A Deed Of Trust State?
In certain states – like California, North Carolina, Georgia, Virginia and Texas – a deed of trust may be used in place of a mortgage. While deeds of trust are similar to mortgage agreements, they differ in two crucial ways.
- Title holder: The most obvious distinction is that deeds of trust require a trustee be included in the real estate transaction. After a borrower finances and purchases a property, a trustee – who acts as a neutral third party – holds the title of the house or property as security until the borrower has repaid the entire loan.
- Foreclosure process: If the borrower can’t repay the loan and ultimately defaults, the foreclosure process is also different. While lenders must go through a judicial foreclosure process for a mortgage, this doesn’t apply to deeds of trust. For a deed of trust state, the lender can execute a non-judicial foreclosure, which means they don’t need to go through the lengthy legal process and are authorized to sell the property as soon as the borrower defaults.
Regardless of these important differences, both mortgages and deeds of trust include due-on-sale clauses. So it doesn’t matter which financing instrument your state uses when it comes to these acceleration provisions.
Due-On-Sale Clause FAQs
The legal terms stipulated in a mortgage can be complex, so let’s go through and review some of the frequently asked questions and common concerns that due-on-sale clauses tend to raise.
The Bottom Line: Due-On-Sale Clauses Protect Lenders
The due-on-sale clause protects your lender by preventing prospective buyers from assuming your mortgage. Remember that if you try to sell or transfer the title of your property, you’ll have to immediately pay off the remaining balance of your mortgage with the proceeds from your sale.
