The Due-on-Sale Clause - Fact and Fiction
What is the due-on-sale clause and how does it affect you, the real estate agent in the current market? The due-on-sale clause (or acceleration clause) is the clause contained in most mortgages that requires the borrower to pay the mortgage loan in full upon sale of the property and is the reason that most real estate related loans are not “assumable.” It gives the lender the right to call the loan due and payable in full when the property is sold.
Financial institutions began using the due-on-sale clause in their real estate loans in the early to mid 1970’s when interest rates began climbing drastically. When the rates began to rise, home buyers found it much cheaper to just assume the existing loans rather than taking out new loans because the existing loans were generally at a much lower rate. Banks used the due-on-sale clause as a way to prevent buyers from assuming loans with a lower than market interest rate.
The thing most people do not understand regarding the due-on-sale clause is that it is a purely contractual issue. It is not illegal to violate the due-on-sale clause and transfer a property without paying the loan in full. It merely gives the bank the right to accelerate the loan if they do find out that the owner transferred the property and begin foreclosure proceedings if the loan is then not paid in full. That is the risk of taking a property subject to a loan that contains a due-on-sale clause and both the seller and the buyer have to be fully aware of the possible consequences.
The Garn-St. Germain Depository Institutions Act of 1982 provides an exception to the lender’s ability to enforce the due-on-sale clause. This exception is “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.” It pays to bear in mind that the Garn-St. Germain Act only applies to residential properties containing 4 dwelling units or less.
With the current condition of the mortgage industry it is becoming increasingly more common to find Buyers who can not qualify for conventional loans. There are several ways for those Buyers to acquire property. Lease Options, Land Contracts, and AITD’s are some of the other more popular ways to accomplish this. Each has their own benefits and risks. In my opinion, transferring the property to a trust is one of the best ways to do this for everyone involved.
The general idea plan goes like this: The Seller sets up a trust as the Beneficiary of the trust and the Buyer as the Trustee. The Seller then will transfer title of the property to the Trustee. This is completely acceptable because of the Garn-St. Germain Act and does not trigger the due-on-sale clause. The Seller would then assign his interest in the trust to the Buyer and the Buyer would then become the Beneficiary. This assignment would trigger the due-on-sale clause but since the assignment is not recorded in any public record, the lender has virtually no chance of discovering the change.
(Please understand that this is a very basic description of the mechanics of the deal. If you or your client wants to sell a property in this manner, please consult an attorney with experience in these type of contracts.)
The Seller is still responsible for the mortgage after the transfer. In a land contract or AITD, the Seller would be forced to initiate foreclosure proceedings in the event of a default on the part of the Buyer. One of the huge benefits for the Seller in transferring the property to the Buyer via a land trust is that the agreement between the Seller and Buyer can be structured in such a way as to allow the Seller to merely evict the Buyer in the case of non-payment. The laws in each state differ in this aspect, but it can put the Seller in a much better position in the event of a default since specific provisions can be written in to the agreement.
There are many benefits for the Buyer as well. First, it can allow them to take advantage of interest rates that may be lower than what they could get on a standard or investor loan. Second, they have no personal liability for the note and it does not show up on their credit report. Third, they can avoid loan costs and possibly get away with a much lower down payment.
The reality of the situation is that in this current market, the banks would most likely be very lenient if they did find out about a transfer of property as long as they are receiving the payments on time. The actual risk of them trying to accelerate the loan and foreclose on the property is virtually nonexistent - what bank wants another REO on the books? Of course, this may change in the future if interest rates go up.
With so many properties on the market, finding a Seller who would be willing to let somebody assume their mortgage is relatively easy. It gives Seller another option in a Buyer’s market. Unfortunately, some Sellers may owe too much on their property these days to make this a viable alternative and might have to look to other methods such as a short sale to get their property sold.
This method gives you, as the real estate agent, another tool in your belt to assist certain Buyers and Sellers and create a win-win situation that benefits everybody involved. As a real estate professional, it is your duty to educate yourself in all aspects of the business. Helping people is the name of the game and extra knowledge will go a long way in winning you life-long clients and the referrals that come from doing a great job.
Steve Didier
