Due-on-Sale Clause in a Mortgage or Trust Deed
Almost every single loan generated to buy a home contains a due-on-sale clause. This clause is important if a homeowner wants to sell their home without paying off the loan. A due-on-sale clause allows the existing lender to call the entire loan due and payable if the homeowner transfers title to the home without paying the loan in full.
A due-on-sale clause prevents a homeowner from selling subject to an existing loan. It doesn't mean that people don't try to do it but it does mean the new homeowner might lose the home if the existing lender forecloses. Lenders have specific rights, and trust deeds and mortgages are written by lawyers in favor of lenders.
What Is a Due-on-Sale Clause?
A due-on-sale clause is one of those rights inherent in the paperwork. You might have to read through 10 pages to find it, but the due-on-sale clause, also known as an acceleration clause, appears in almost all loans made after 1988. Sample verbiage found in a mortgage for a one- to four-family dwelling is as follows:
Transfer of the Property or a Beneficial Interest in Borrower. If all or any part of the Property or any interest in it is sold or transferred (or if a beneficial interest in Borrower is sold or transferred and Borrower is not a natural person) without Lender's prior written consent, Lender may, at its option, require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if exercise is prohibited by federal law as of the date of this Security Instrument.
The reason you care about a due-on-sale clause is that you don't want the lender to suddenly demand a payoff, which the lender can do legally. However, in the real world, lenders are not often calling loans due and payable simply because the title to the property is transferred.
Especially during the market collapse between the years 2006 and 2011, because lenders at that point were simply thrilled to be paid at all, they didn't care who paid them as long the mortgage was not delinquent.
When the Due-on-Sale Clause Is Enforced
Today, lenders still have the right to accelerate the loan if they feel their security could potentially be damaged. After all, they made the loan to a borrower after fully vetting the buyer and running the file through underwriting and they do not know this new person making the payments or their creditworthiness.
Mortgages with due-on-sale clauses are not assumable.
Generally, a due-on-sale clause is enforced if the lender feels its security is at risk or if the lender believes it can make more money in a climate of rising interest rates. For example, if the bank can enforce a payoff of that existing loan, which might be at a lower-than-market interest rate, and then use that money to fund a new loan at a higher rate, it is in the bank's best interest to call that loan immediately due and payable. This could leave borrowers scrambling to refinance.
In the 1970s and 1980s, banks would offer formal loan assumptions to new buyers, but we don't see much of that anymore. If buyers did not qualify, these types of buyers would often try to buy the property without informing the lender, either wrapping the existing financing into an All-inclusive Trust Deed or a Wrap-Around Land Contract. Some used lease option sales as a financing instrument to try to sidestep the due-on-sale clause.
Exceptions to Due-on-Sale Clauses
There are situations when lenders are unable to exercise their right to collect the full payment, such as:
- The borrower is deceased, and the property is transferred to a relative.
- The transfer occurs between the children or spouse of the borrower.
- The transfer occurs based on a decree from a separation, divorce, or property settlement agreement.
Due-on-sale clauses are designed to protect lenders from losing money in the event that a homeowner defaults on their payments. This clause keeps homeowners from transferring their debt to an unknown buyer who may default on their payments. Rather, homeowners must use the proceeds from the sale of their home to repay the debt to the lender, and the buyer must take out another home loan to pay for their mortgage. Understand this provision before signing on the dotted line.