Due-on-sale clause
Encyclopedia
A due-on-sale clause is a clause in a loan
or promissory note
that stipulates that the full balance may be called due upon sale or transfer of ownership of the property used to secure the note. The lender has the right, but not the obligation, to call the note due in such a circumstance.
In real estate investing
, the due-on-sale clause can be an impediment for a property owner who wishes to sell the property and have the buyer take over an existing loan rather than paying the loan off as part of the sale. Likewise, a due-on-sale clause would interfere with a seller's extension of financing to a buyer by using a wraparound mortgage
, also called an "all-inclusive mortgage" or "all-inclusive deed of trust." Either of these arrangements triggers the due-on-sale clause in the seller's existing mortgage and thus the lender may call the loan due. If a property with a due-on-sale clause in the mortgage loan is transferred and the loan is not paid off, the bank could foreclose
on the property. How likely this is depends on how the real estate economy is doing. If the buyer continues to pay the loan payments when due, it is less likely that the bank would actually call the loan due but still the bank's choice. In the early 1980s, with interest rate
s on new loans at 18%, banks attempted to enforce these clauses in older loans so that they could lend the funds out at higher interest. In the 2010 lending market many observers believe that banks are not likely to enforce due-on-sale provisions unless they have another reason to call the loan due.
in the past. Until 1982, the enforceability of due-on-sale provisions was basically a matter of state, not federal, law. Many States had adopted laws that permitted existing loans to be assumed by buyers whether or not the lender was willing to agree. The logic behind these laws was generally that a lender should only be permitted to call a loan due when the property securing the loan is sold if the lender could demnonstrate that the sale and transfer of the property reduced the lender's security or increased the risk that the loan would go into default.
However, in 1982 Congress passed the by the Garn–St. Germain Depository Institutions Act. Section 341a of the Act (codified in Title 12, U.S. Code, Section 1701j-3) makes the enforceability of due-on-sale provisions a federal issue, and provides that if real estate loan documents contain a due-on-sale provision, that provision is enforceable if the property securing the loan is transferred without the lender's consent. Institutional lenders lobbied Congress heavily to add Section 341a of the Act to federal law and their lobbying efforts were successful.
Lenders are generally not required to include due-on-sale provisions in loans, but it is nearly universal practice for institutional lenders to include them. For loans by private lenders, such as financing extended to buyers by sellers, due-on-sale provisions are not always included. Also, a buyer and seller could negotiate to include due-on-sale clause that allows a one-time loan assumption.
There are certain exceptions to enforceability of due-on-sale clauses. These are generally contained in Title 12, Code of Federal Regulations, Section 551. For example, borrowers may place their homes in their own trust
without triggering the due-on-sale clause. "A lender may not exercise its option pursuant to a due-on-sale clause upon 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." (12 U.S.C. 1701j-3(d)(8)..[5].) Note that a beneficiary
means possibly among multiple beneficiaries. Similarly, transfer of the borrower's home to a spouse as part of a divorce or dissolution of marriage generally does not trigger a due-on-sale clause. There are other exemptions in the law as well. Use trusts also facilitates transfers of property to heirs
and minors
. It may also protect the property of wealthy or risky owners against the possibility of future lawsuits or creditor
s, because the trust owns the property, not the individuals at risk.
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
or promissory note
Promissory note
A promissory note is a negotiable instrument, wherein one party makes an unconditional promise in writing to pay a determinate sum of money to the other , either at a fixed or determinable future time or on demand of the payee, under specific terms.Referred to as a note payable in accounting, or...
that stipulates that the full balance may be called due upon sale or transfer of ownership of the property used to secure the note. The lender has the right, but not the obligation, to call the note due in such a circumstance.
In real estate investing
Real estate investing
Real estate investing involves the purchase, ownership, management, rental and/or sale of real estate for profit. Improvement of realty property as part of a real estate investment strategy is generally considered to be a sub-specialty of real estate investing called real estate development...
, the due-on-sale clause can be an impediment for a property owner who wishes to sell the property and have the buyer take over an existing loan rather than paying the loan off as part of the sale. Likewise, a due-on-sale clause would interfere with a seller's extension of financing to a buyer by using a wraparound mortgage
Wraparound mortgage
A wrap-around mortgage, more-commonly known as a "wrap", is a form of secondary financing for the purchase of real property. The seller extends to the buyer a junior mortgage which wraps around and exists in addition to any superior mortgages already secured by the property...
, also called an "all-inclusive mortgage" or "all-inclusive deed of trust." Either of these arrangements triggers the due-on-sale clause in the seller's existing mortgage and thus the lender may call the loan due. If a property with a due-on-sale clause in the mortgage loan is transferred and the loan is not paid off, the bank could foreclose
Foreclosure
Foreclosure is the legal process by which a mortgage lender , or other lien holder, obtains a termination of a mortgage borrower 's equitable right of redemption, either by court order or by operation of law...
on the property. How likely this is depends on how the real estate economy is doing. If the buyer continues to pay the loan payments when due, it is less likely that the bank would actually call the loan due but still the bank's choice. In the early 1980s, with interest rate
Interest rate
An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for...
s on new loans at 18%, banks attempted to enforce these clauses in older loans so that they could lend the funds out at higher interest. In the 2010 lending market many observers believe that banks are not likely to enforce due-on-sale provisions unless they have another reason to call the loan due.
United States law
Virtually all mortgage loans made in the United States by institiutional lenders in recent years contain a due-on-sale clause. This is in contrast to the wide availability of assumable mortgagesAssumption of mortgage
Assumption of mortgage is the purchase of mortgaged property whereby the buyer accepts liability for an existing debt secured by a mortgage on the property. This generally requires the consent of the lender that owns or services the existing loan...
in the past. Until 1982, the enforceability of due-on-sale provisions was basically a matter of state, not federal, law. Many States had adopted laws that permitted existing loans to be assumed by buyers whether or not the lender was willing to agree. The logic behind these laws was generally that a lender should only be permitted to call a loan due when the property securing the loan is sold if the lender could demnonstrate that the sale and transfer of the property reduced the lender's security or increased the risk that the loan would go into default.
However, in 1982 Congress passed the by the Garn–St. Germain Depository Institutions Act. Section 341a of the Act (codified in Title 12, U.S. Code, Section 1701j-3) makes the enforceability of due-on-sale provisions a federal issue, and provides that if real estate loan documents contain a due-on-sale provision, that provision is enforceable if the property securing the loan is transferred without the lender's consent. Institutional lenders lobbied Congress heavily to add Section 341a of the Act to federal law and their lobbying efforts were successful.
Lenders are generally not required to include due-on-sale provisions in loans, but it is nearly universal practice for institutional lenders to include them. For loans by private lenders, such as financing extended to buyers by sellers, due-on-sale provisions are not always included. Also, a buyer and seller could negotiate to include due-on-sale clause that allows a one-time loan assumption.
There are certain exceptions to enforceability of due-on-sale clauses. These are generally contained in Title 12, Code of Federal Regulations, Section 551. For example, borrowers may place their homes in their own trust
Trust law
In common law legal systems, a trust is a relationship whereby property is held by one party for the benefit of another...
without triggering the due-on-sale clause. "A lender may not exercise its option pursuant to a due-on-sale clause upon a transfer into an inter vivos trust in which the borrower is and remains a beneficiary
Beneficiary
A beneficiary in the broadest sense is a natural person or other legal entity who receives money or other benefits from a benefactor. For example: The beneficiary of a life insurance policy, is the person who receives the payment of the amount of insurance after the death of the insured...
and which does not relate to a transfer of rights of occupancy in the property." (12 U.S.C. 1701j-3(d)(8)..[5].) Note that a beneficiary
Beneficiary
A beneficiary in the broadest sense is a natural person or other legal entity who receives money or other benefits from a benefactor. For example: The beneficiary of a life insurance policy, is the person who receives the payment of the amount of insurance after the death of the insured...
means possibly among multiple beneficiaries. Similarly, transfer of the borrower's home to a spouse as part of a divorce or dissolution of marriage generally does not trigger a due-on-sale clause. There are other exemptions in the law as well. Use trusts also facilitates transfers of property to heirs
Inheritance
Inheritance is the practice of passing on property, titles, debts, rights and obligations upon the death of an individual. It has long played an important role in human societies...
and minors
Minor (law)
In law, a minor is a person under a certain age — the age of majority — which legally demarcates childhood from adulthood; the age depends upon jurisdiction and application, but is typically 18...
. It may also protect the property of wealthy or risky owners against the possibility of future lawsuits or creditor
Creditor
A creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property or...
s, because the trust owns the property, not the individuals at risk.
See also
- Promissory notePromissory noteA promissory note is a negotiable instrument, wherein one party makes an unconditional promise in writing to pay a determinate sum of money to the other , either at a fixed or determinable future time or on demand of the payee, under specific terms.Referred to as a note payable in accounting, or...
- Assumption of mortgageAssumption of mortgageAssumption of mortgage is the purchase of mortgaged property whereby the buyer accepts liability for an existing debt secured by a mortgage on the property. This generally requires the consent of the lender that owns or services the existing loan...
- Mortgage noteMortgage noteIn the US a mortgage note is a promissory note associated with a specified mortgage loan; it is a written promise to repay a specified sum of money plus interest at a specified rate and length of time to fulfill the promise...
- Mortgage law