The due on sale clause in a mortgage or trust deed
This is actually a fairly common question with loans, and it comes in many forms. What does due mean, what does due by mean, due on sale clause example, what is a due on sale clause, what about a wrap around mortgage due on sale clause and many others.
A due on sale clause is very important if you have a homeowner who wants to sell, without first paying off the loan. In this case, the existing lender can call the loan due on and payable. This only applies if the homeowner transfers the home title without paying off the loan completely.
Let’s take a look at a due on sale clause sample
A due-on-sale-clause is also known as a mortgage due on sale clause, and you might even find it as an acceleration clause in real estate situations, because it applies in both deed of trust or mortgages, and requires that the loan balance is paid if you want to secure a mortgage for the property.
A bank or mortgage lender uses this clause to prevent the buyer from assuming the mortgage at the original interest rate, and buyers will have to renegotiate a new interest rate. This is pretty much the due on sale definition.
The due on sale clause mortgage, or loan, is not illegal, per se
Many people think that if you transfer the title to a property which is secured by a due on sale mortgage, you’re breaking the law. This is a mistake, and you are confusing criminal liability with civil liability.
There is no law which makes violating this clause a crime. However, if the lender finds out about the transfer, he has the right to call the loan due, and payable. If it can not be paid, they can begin with foreclosure proceedings.
The question about the legal due on sale meaning is whether you’d risk taking a property like that, with the risk of getting caught?
Trust assignment as a solution
The trick here is to transfer ownership without the lender finding out. Now, you could get the owner to sign and not record it, but what if the seller gets a judgment against him? This is where the trust assignment comes into play, as you need to look at some exceptions which might help you.
What are the exceptions?
The lender, who can exercise his option pursuant to the clause, can choose not to do so upon:
- The creation of any lien, or another subordinate, to the security instrument of the lender which has nothing to do with the transfer of rights of the property
- The creation of a money security interest for any household items or appliances
- A transfer by descent, devise, or death of a tenant by the entirety, or joint tenant
- The grant of a leasehold interest of no more than 3 years, with no option to purchase
- A transfer to a relative which resulted from the borrower’s death
- A transfer where the borrower’s children or spouse become owners
- A transfer which results from a legal separation agreement, or incidental property settlement, by which the spouse becomes the owner
- A transfer into a trust, where the borrower remains a beneficiary, which doesn’t relate to a transfer of rights of occupancy
- Any other transfer which is described in the Federal Home Loan Bank Board’s regulations
This bank board states that the Act only applies to homes that are owner-occupied. However, the Garn Act’s clear language states that it applies to any residential, one-to-four family homes, where “owner-occupied” isn’t mentioned anywhere.
What is the land trust?
Under the Garn Act, we have a land trust, which is a form of revocable, living trust. This is created by two legal documents. The first is a trust agreement between the trust creator or grantor, and the trustee, with a clear definition of the trust arrangement, and the second is a deed, from the grantor to the trustee.
The trustee will hold the title for the grantor’s benefit. If you place the title to a property into such a trust, you aren’t violating the due on sale, as long as there isn’t any change in occupancy.
Now, let’s say you find a seller who wants to give you title to his property, but the loan isn’t assumable. Why? Because the mortgage comes with a “due on sale” clause. Here is how you can get around this.
First, the seller will sign a trust agreement, and make you a trustee. He is named as the beneficiary. He will transfer the title to the trustee, which doesn’t violate the clause.
They will also quietly assign their interest under the trust to you. This is an assignment which isn’t recorded in any public record, and the seller is free to move out in order for you to move in. You’re the beneficiary of the trust, and your trustee continues making payments to the lender.
Now, when the seller assigns the interest to you, this triggers the due on sale. But, how would the lender find out? There are three potential ways of this happening.
The first is a change of name on the deed itself. The lenders usually don’t have people checking this at the recorder and clerk’s office, and this isn’t very likely. The second is the different name on the payment check. The bank officers are far from the workers who process the payments, which makes this a not likely option too.
The last one is the change of the hazard insurance beneficiary. This is how the lender usually finds out because they’re also a named beneficiary and are obliged to receive a copy of the change.
Now, if you transferred the title into a land trust, the new beneficiary is the trustee. The lender shouldn’t object because they would assume that the seller has an estate planning device in place. If the trust’s beneficiary is assigned, the lender won’t be notified, since the beneficiary of the insurance hasn’t changed.
You will find that this strategy isn’t much different from just transferring the title directly, but this way, the chances of the lender discovering this happened are reduced by a lot.
And, when the lender has contracted a company to deal with the loan, this is even truer. Servicing companies are usually poorly managed, and more than 95% of them don’t even know what a “due on sale” clause is.
Let’s get it straight – is it fraud, or unethical?
Looking at it from a legal standpoint, if an agent doesn’t tell the lender about the transfer, he didn’t breach ethics. In fact, some standard contracts will even have provisions that contemplate a “subject to” transfer.
This situation has come up in various states, and most of them, including California, Utah, New York, Alaska, and Illinois, these situations were proclaimed not to be fraud or breach of trust. They are also not any kind of crime, and lawyers were even helping their clients conceal the transfer, which was also not an ethical problem.
Ending thoughts on a due on sale clause
“Due on sale” is a term that is talked about plenty in the real estate investing, and is one of the most controversial, and consequently, misunderstood topics.
With the article above, you should know what the clause means, and what happens in any situation, and you also have an effective strategy to get around it, should you ever face it as a problem.
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