It used to be common for mortgages to be assumable by prospective buyers. However, in 1982, Congress passed the Garn-St. Germain Depository Institutions Act, a section of 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 that the remaining balance of a mortgage be repaid in full in the event that a property is sold or transferred. This clause protects lenders by preventing buyers from being able to assume a mortgage that has a below-market interest rate. However, there are some exceptions to this clause, including transfers to spouses, children and trusts.
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.
In order to ensure that 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 that has a low interest rate or terms that the buyer would otherwise be unqualified to obtain.
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 that they will not ultimately be able to recoup their costs by foreclosing on the property.
Are There Exceptions To The Due-On-Sale Clause Law?
Despite the prevalence of due-on-sale clauses, there are certain legal exceptions that negate lenders’ right 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 then occupies the home, the relative cannot 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 is applicable to any circ*mstances in which 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 cannot 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 in the event that the borrower dies. Instead, the surviving joint tenant automatically assumes the entire mortgage and can pay it off as initially planned.
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 lieu 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 that 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 is unable to repay the loan and ultimately defaults, the foreclosure process is also different. While lenders must go through a judicial foreclosure process in the case of a mortgage, this is not the case for deeds of trust. For a deed of trust state, the lender can execute a non-judicial foreclosure, which means that they don’t need to go through the lengthy legal process and instead 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 common frequently asked questions and concerns that due-on-sale clauses tend to raise.
What does it mean for a mortgage to be assumable?
An assumable mortgage allows a new buyer to legally take possession of the seller’s existing loan instead of obtaining their own financing to fund the purchase of the property.
Is a due-on-sale clause the same as an acceleration clause?
Due-on-sale clauses – also called alienation clauses – are a type of acceleration clause. Similar to due-on-sale clauses, acceleration clauses allow your mortgage lender to demand full repayment of your home loan. The difference is that a due-on-sale clause is triggered when you sell or transfer your property without the lender’s consent, whereas an acceleration clause goes into effect when you miss mortgage payments, file for bankruptcy or fail to fulfill your loan requirements in some other way.
Do all mortgages have a due-on-sale clause?
Although the majority of mortgages contain due-on-sale clauses, there are still some mortgages that are assumable. Such mortgages include the Department of Veterans Affairs (VA), Federal Housing Administration (FHA) and United States Department of Agriculture (USDA) loans. Even though these types of loans are assumable, prospective buyers must still qualify for the loan.
If a mortgage contains a due-on-sale clause, can the borrower still pay off the mortgage early?
Yes. A due-on-sale clause does not impact a borrower’s ability to pay off their mortgage early. However, before doing so, you should check to ensure that your lender doesn’t charge prepayment penalties.
What happens if a borrower sells or transfers the property without informing their lender?
As mentioned, lenders are notified when properties are transferred to another party, so the lender will likely exercise their acceleration rights and can begin foreclosure proceedings. Therefore, borrowers should not try to avoid triggering the due-on-sale clause by transferring the property behind the lender’s back. If they do, it’s likely that the new owner will lose the property through foreclosure.
Are there circ*mstances in which the lender would not invoke the due-on-sale clause?
Lenders are less likely to invoke the due-on-sale clause when they fear that they’ll be unable to recover the funds loaned to the borrower. Therefore, lenders may allow the mortgage to be assumed by the prospective buyer if the housing market is weak, and the lender believes doing so will increase the chances that the loan will be repaid.
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.
If you’re learning about due-on-sale clauses because you’re planning to sell your current house and buy another, or because you’re buying a house for the first time and want to fully understand the terms of the mortgage you’ll be taking on, get started today.
