How to Avoid the Due on Sale Clause

A due-on-sale clause is a provision commonly found in mortgage contracts that requires the borrower to repay the entire outstanding loan balance upon the sale or transfer of the property. This contractual right, also known as an acceleration clause, allows the lender to demand immediate repayment of the loan if ownership changes without their prior written consent.

The primary purpose of this clause from the lender’s perspective is to protect their investment and maintain control over the mortgaged property. Lenders underwrite loans based on the specific borrower’s financial profile and the collateral property. The clause ensures that the loan is not transferred to a new owner whom the lender has not vetted. It also allows lenders to re-evaluate loan terms or interest rates upon a transfer, aligning with current market conditions. Most U.S. mortgage loans, particularly conventional ones, include due-on-sale clauses, making them generally enforceable.

Understanding Legal Exemptions

Federal law provides specific situations where lenders are prohibited from enforcing a due-on-sale clause, even if a property transfer occurs. The Garn-St. Germain Depository Institutions Act of 1982 outlines these exemptions for residential real property with fewer than five dwelling units. These exceptions protect homeowners in various common circumstances, particularly those involving family transfers or estate planning.

One exemption applies to a transfer to a spouse, child, or other relative resulting from the death of the borrower. This allows the inheriting relative to continue with the existing mortgage payments, provided the property is residential.

Another exemption covers transfers to a spouse or children of the borrower during their lifetime, such as through a divorce decree, legal separation agreement, or as a gift. These transfers do not trigger the due-on-sale clause, ensuring continuity of the mortgage.

A transfer into an inter vivos trust, also known as a living trust, is also exempt under certain conditions. The borrower must remain a beneficiary of the trust and continue to occupy the property for this exemption to apply. This provision allows for estate planning without triggering the loan’s acceleration.

The creation of a lien or encumbrance subordinate to the mortgage, such as a second mortgage or home equity line of credit, is also exempt. This allows homeowners to utilize their property’s equity without fear of the primary mortgage being called due, as long as it does not relate to a transfer of occupancy rights. Similarly, the creation of a purchase money security interest for household appliances is also protected.

Finally, a transfer by devise, descent, or operation of law upon the death of a joint tenant or tenant by the entirety is exempt. This addresses situations where co-ownership of a property automatically transfers to the surviving owner upon the death of another. This ensures that the mortgage remains intact during such automatic transitions of ownership.

Exploring Alternative Transaction Structures

Beyond legal exemptions, individuals sometimes explore non-traditional methods to transfer property or control without directly triggering the due-on-sale clause. These approaches often involve creative financing or ownership arrangements, though they carry potential implications if discovered by the lender. Such structures attempt to bypass the formal “sale” event that typically triggers the clause.

One such arrangement is a “subject-to” mortgage, where a buyer takes over payments on an existing mortgage without formally assuming the loan. The original borrower remains primarily liable on the loan, and the deed is transferred to the new buyer. If the lender discovers this type of transfer, they retain the right to accelerate the loan and demand full repayment. The original borrower also remains legally responsible for the mortgage, which can present continued liability if the new party defaults.

Land contracts, also known as contracts for deed, represent another alternative structure. In these agreements, the buyer takes possession of the property and makes payments directly to the seller, but legal title remains with the seller until the contract terms are fully satisfied. This arrangement delays the formal transfer of legal title, aiming to circumvent the due-on-sale clause. Lenders may still view a land contract as an equitable transfer of interest, potentially triggering the due-on-sale clause if they become aware of the arrangement.

Lease options or lease-purchase agreements involve a tenant leasing a property with the option to purchase it at a future date, often with a portion of the rent applied toward the purchase price. While this is not an immediate sale, these arrangements can still attract lender scrutiny. Lenders might consider extended lease terms combined with a purchase option as resembling an installment sale. Such arrangements could trigger the clause, as the Garn-St. Germain Act generally exempts only leasehold interests of three years or less without a purchase option.

Seeking Lender Approval

Directly approaching the existing lender to request permission for a transfer or assumption of the loan is a viable pathway, despite the presence of a due-on-sale clause. While lenders generally enforce these clauses to protect their interests, there can be specific circumstances where they are willing to work with borrowers. This willingness often arises when the lender seeks to avoid a potential default or foreclosure.

The process typically involves initiating contact with the lender to discuss the possibility of a loan assumption. The proposed new borrower will usually need to provide comprehensive financial information, similar to a new loan application. This includes details regarding their credit history, income, and assets, allowing the lender to assess their financial capacity to take on the mortgage.

Lenders may then re-underwrite the loan based on the new borrower’s financial profile. This re-underwriting could lead to adjustments in the loan terms, such as the interest rate or the imposition of new fees. The lender might agree to the assumption if the new borrower presents a stronger financial standing, reducing the lender’s perceived risk.

Potential outcomes of this negotiation include approval with modified terms, or a denial of the assumption request. Success is not guaranteed, as the decision rests solely at the lender’s discretion. Certain government-backed loans, such as FHA, VA, and USDA loans, are generally more assumable, provided the new borrower meets specific qualifications.