The "due-on-sale" clause is probably the most, feared and misunderstood topic in real estate. This article will break down the due-on-sale clause and discuss why it is not the feared animal most people make it out to be.
What is the Due-on-Sale Clause?
This is the exact clause taken from Form 3024 1/01 - MINNESOTA - Single Family - Fannie Mae/Freddie Mac Uniform Instrument:
||***18. Transfer of the Property or a Beneficial interest in Borrower. As used in this Section 18, "Interest in the Property" means any legal or beneficial interest in the property, including, but not limited to, those beneficial interests transferred in a bond for deed, contract for deed, installment sales contract or escrow agreement, the intent of which is the transfer of title by Borrower at a future date to purchaser. If all or any part of the Property or any Interest in the Property is sold or transferred (or if Borrower is not a natural person and a beneficial interest in Borrower is sold or transferred) without Lender's prior written consent, Lender may require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if such exercise is prohibited by Applicable Law. If Lender exercises this option, Lender shall give Borrower notice of acceleration. This notice shall provide a period of not less than 30 days from the date the notice is given in accordance with Section 15 within which Borrower must pay all sums secured by this Security Instrument. If Borrower fails to pay these sums prior to the expiration of this period, Lender may invoke any remedies permitted by its Security Instrument without further notice or demand on Borrower.***
The due-on-sale (a.k.a "acceleration clause") gives the lender the right to call the loan due. It does not say that the loan must be called due, only that the lender has the option, if they so choose.
Where Did the Due-on-Sale Clause Come From?
Banks began inserting due-on-sale clauses in their mortgages in the 1970s when interest rates rose dramatically. Homebuyers were assuming existing loans rather than borrowing new money from banks because the interest rates on existing loans were lower. The banks realized that their old, lower interest loans were their own, toughest competitor. The banking industry came up with the "Due-on-Sale" Clause. It is a contractual agreement only. It is not law.
This plan worked. The banks were able to force new home purchasers to get a new loan (at the higher interest rates) and pay off the lower interest rates when a property was sold or transferred.
But... Today, interest rates keep dropping and the new loans are at lower interest rates than the old ones. Could you see the banks wanting to call these higher interest rate loans due, just to make new ones at lower interest rate. I don't think so.
As long as the rates stay where they are, it doesn't make financial sense for the banks to call these loans due. Even if the rates are the same or just a little higher. You see, the process to foreclose on a loan that is still in good standing, just because the ownership transferred would be expensive. And, if you live in a state with long redemption periods like Minnesota, which has a 6-month redemption period after the sheriff's sale, the process to foreclose would be long and expensive for the banks. As long as the loan is current, and in good standing with the bank, they would much rather keep taking your payments.
Is it Illegal to transfer ownership of property with the due-on-sale clause?
Many people are under the mistaken impression that transferring title to a property secured by a "due-on-sale" mortgage is illegal. This is because most people have never read the Due-on-sale clause. They just listen to what the Realtors® tell them. I would venture to guess that most Realtors® have never read the due-on-sale clause, or the Garn St. Germain Act. If the lender discovers the transfer, it may at its option, call the loan due and payable. If it cannot be paid, the lender has the option of foreclosing.
|Garn St. Germain Act: (US Code / Title 12 - Banks and Banking / Chapter 13 - National Housing / 1701j-3 Preemption of due-on-sale prohibitions.
There are several exceptions in which the lender may not enforce the due-on-sale: The one they are referring to is in section:
||Exemption of specified transfers or dispositions...
||a transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property; or
What is a Land Trust?
A land trust is a form of a revocable, living trust, which is exempted under the Garn St. Germain Act. A land trust is a legal entity for taking title to real property.
The trustee holds title for the benefit of the grantor (in this case, the grantor is also the "beneficiary"). The act of placing your property into a land trust does not trigger the due-on-sale clause. However, transfer of the beneficial interest does.
How do I buy a house “Subject-To” with the due-on-sale clause?
Let's say that you find a house in pre-foreclosure. The seller is willing to give you title to his property if you stop the foreclosure and save his credit. The only "glitch" is that the loan is not assumable because the mortgage has a due-on-sale clause. So you pass, right? Wrong...
The first thing you need to find out is all the facts the seller has represented to you. Do your due diligence. Get a title company or Attorney to do a Title search. This will tell you the amount of the mortgage, if there is a second or a third mortgage, and if there are any liens or judgments against the property.
If you are satisfied with the title search, then you may proceed with the transaction. Get the property under contract. Along with the Purchase agreement, you will need to get an “Authorization to release information” signed by the Sellers. This is the only document that will allow the Lender to release any information about this loan to you. If the loan has already been turned over to the attorneys for foreclosure, then you will also need this document for them.
You will need to request the loan balance, monthly payment, amount of arrearage (if any) and amount to bring the loan current. If the lender is willing to work with you at this point, you have half the battle won. Most Lenders (and attorneys) will work with you at this point. The most important thing to them is bringing this loan current.
The banks get punished for having “non-performing assets” on their books. For every $1.00 in bad dedt on their books, they are not allowed to lend back out $8.00. (Example: the bank has to foreclose and take back a property with a $100,000 mortgage, that means they are not allowed to lend out $800,000, until that house is sold, and off their books.) That is why the banks are usually willing to deal with us, even though they know the loan will be taken subject-to the existing loan, which has a due-on-sale clause in the mortgage.
Next, GET THE DEED!!! Once you have the deed, then you have control of the property. Go ahead and make the back payments and arrearages. You now own the property, and the loan is current. If the bank is not going to take the payments from you, then you also know at this point that they are calling the loan due (which is rare, but does happen). At least you know, you have not spent any money on this property, except for a few dollars on a title search, and some of your time. But most of the time, the lender will take your money. They will re-instate the loan for you, and you own a property that you bought subject-to, with an existing loan that you did not originate, did not sign for, and has a “Due-On-Sale” clause in it.
As long as the interest rates stay low, the “Due-on-sale” clause should not be feared, only understood.