What Is a Due-on-Sale Clause in a Mortgage?

A due-on-sale clause is a standard provision in mortgage or deed of trust agreements. It grants the lender the right to demand full repayment of the outstanding loan balance if the property securing the mortgage is sold or transferred. This protects the lender’s financial interest.

Defining the Due-on-Sale Clause

A due-on-sale clause, also known as an alienation clause, gives the mortgage lender the right, but not always the obligation, to accelerate the loan. This means the entire outstanding principal balance becomes immediately due and payable if the borrower sells, gifts, or transfers any interest in the property without the lender’s prior written consent. Lenders include these clauses to prevent loan assumptions, particularly when market interest rates are higher than the existing loan’s rate, allowing them to issue new loans at current market rates and vet new borrowers. It is a type of acceleration clause.

Triggers for the Due-on-Sale Clause

Various types of property transfers can activate a due-on-sale clause. An outright sale of the property, where a new owner takes possession, is the most common trigger. Even if no money changes hands, transferring the property title through a deed, such as gifting the property to a family member or friend, can also cause the clause to be invoked. Entering into a land contract or installment sale agreement, where the seller retains legal title while the buyer makes payments and occupies the property, may also trigger this provision. Furthermore, transferring ownership into certain types of trusts, particularly irrevocable trusts, or adding or removing co-borrowers, can be seen by the lender as a change in ownership that activates the clause.

Exemptions to the Due-on-Sale Clause

Despite the broad reach of due-on-sale clauses, federal law provides specific situations where lenders cannot enforce them. The Garn-St. Germain Depository Institutions Act of 1982 prohibits lenders from exercising this option in several common scenarios involving residential property with fewer than five dwelling units. These exemptions include transfers by devise, descent, or operation of law upon the death of a joint tenant or tenant by the entirety, where the property automatically passes to the surviving owner. Transfers to a relative resulting from the death of the borrower, or transfers to a spouse or children of the borrower, are also protected.

The clause also cannot be enforced for transfers resulting from a divorce decree, legal separation agreement, or incidental property settlement, where a spouse becomes the owner. Another significant exemption covers transfers into an inter vivos (living) trust, provided the borrower remains a beneficiary of the trust and the occupancy of the property is not disturbed. Additionally, the creation of a junior lien, such as a second mortgage or a home equity line of credit (HELOC), typically does not trigger the due-on-sale clause. While these exemptions provide significant protections, lenders may still require notification of such transfers.

Implications of a Due-on-Sale Clause

If a due-on-sale clause is triggered and the lender decides to enforce it, the primary implication is loan acceleration. This means the entire outstanding principal balance of the mortgage, along with any accrued interest, becomes immediately due and payable. Borrowers who cannot pay the accelerated amount face severe consequences, potentially leading to foreclosure proceedings initiated by the lender to recover the debt. The lender has the option to enforce the clause, but it is not an automatic requirement, and they may choose not to if it is not financially advantageous, such as in a low-interest rate environment.

This clause effectively prevents unauthorized loan assumptions, ensuring that a new buyer cannot simply take over an existing mortgage, especially one with a favorable interest rate. The lender wants to underwrite a new loan based on the current market conditions and the new borrower’s financial profile. Failure to comply with the due-on-sale clause, even if the lender initially tolerates the transfer, can damage the borrower’s credit history and future borrowing capacity.