What is an alienation clause?
How is it used in real estate transactions and mortgages?
How does it work in simple terms?
This article will break down the notion of “alienation clause” so you know all there is to know about it!
We will look at what is an alienation clause, look at its definition and meaning, how it is relevant in real estate, look at its enforcement and enforcement exceptions, compare it to an acceleration clause and an assumable mortgage, look at examples and more!
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What is an alienation clause
An alienation clause (also known as the due-on-sale clause, non-alienation clause or anti-alienation clause) is typically found in loan agreements, mortgages, deeds of trust or insurance contracts whereby the lender has the right to request the repayment for the outstanding balance of the loan in certain events.
In other words, if a person borrowed money from the bank to purchase a house and still has a financial obligation under the loan contract to pay principal and interest, the full balance of the sums borrowed will become immediately due and payable on a future sale.
In the context of a real estate transaction, the borrower must pay the remaining balance on the mortgage to transfer title to the property.
Mary purchases a new home for $300,000 where she makes a $50,000 cash down payment and takes on a mortgage for $250,000.
In her deed of mortgage, the bank will include an alienation clause to ensure that Mary is restricted from assigning the mortgage and title to her property to someone else.
Should Mary choose to sell her house in the future, her mortgage’s remaining and unpaid balance will become due on the date of the sale.
The objective of the alienation clause is to:
- Ensure that when the borrower decides to sell the property in the future, the outstanding loan balance becomes due on the date of the sale (closing date)
- Ensure that the borrower does not transfer or assign the mortgage to someone else without the lender’s approval.
The due-on-sale clause produces legal effects whether the transfer of property by one party was voluntary or involuntary.
Alienation clause definition
To define alienation clause, let’s first see what the term “alienation” means.
According to the Merriam-Webster dictionary, the term alienation means:
To convey or transfer (something, such as property or a right) usually by a specific act rather than the due course of law
Alienation real estate is the act of selling, transferring or conveying title to a property.
Now, let’s look at the definition of alienation clause.
According to Century 21, an alienation clause is defined as:
An alienation clause is a mortgage provision that requires the borrower to pay the balance of the loan after the sale or transfer of the property.
Alienation clause real estate is a contractual provision prohibiting the borrower from assigning the real estate mortgage or debt to someone else and giving the lender the right to call back the loan in the event of a sale.
Alienation clause in real estate
In nearly all of the mortgage agreements today, it is standard for lenders to include an alienation provision.
It is unlikely that a lender assumes the risk of having a borrower transfer the deed of mortgage to someone else without the lender’s approval.
In the context of the alienation of property, the “alienation clause” protects the lender (bank, financial institution, creditor, financing company or any other type of lender) in the following manner:
- The borrower cannot transfer the loan to someone who does not have good credit or qualify with the same lender (third party credit risk)
- The borrower keeps the title to the property until the loan is fully paid to secure the loan in case of a default (mortgage security)
- The borrower does not transfer the mortgage or loan based on past interest rates or terms no longer dictated by the market (market risk)
- The borrower must pay back the outstanding balance of the loan from the proceeds of the sale (debt repayment)
How does the alienation clause work practically speaking?
Simply said, due to the legal prohibition imposed on the borrower to sell, transfer or assign the mortgage on the date of the sale, if a property owner wishes to transfer title to the property (alienate property), he or she must pay off the bank on the date of the closing.
Typically, the seller will use the sale proceeds to pay off the bank loan before the title is transferred to the buyer.
Alienation clause enforcement
Alienation provisions are generally enforceable.
A lender can choose to enforce the alienation right or not.
However, in most cases, you should expect lenders to enforce their contractual rights to ensure they are protected and prevent financial losses.
There are some enforcement exceptions when a mortgage, loan contract or deed of financing can be transferred by the borrower to someone else without triggering the alienation clause in mortgage.
Typically, you can expect to be able to transfer or assign your mortgage without having to pay off the debt in the following circumstances:
- You are transferring the property to a joint owner
- When the property owner passes away or the event of death
- In the context of a divorce or separation
- When the property is transferred into a living trust
- When the homeowner wishes to get a second mortgage
The Garn-St. Germain Depository Institutions Regulations Act of 1982 provides outlines certain exceptions to the enforcement of an alienation clause.
It’s essential to verify your right of alienation under the contract before you make any decisions that may result in the unintended trigger of the alienation clause.
Alienation clause vs acceleration clause
An alienation clause is a type of clause typically found in contracts where one party may have a financial obligation towards another such as a loan, mortgage or other financial contracts.
The purpose is to ensure that a contracting party fulfills their financial obligations in full before having the right to alienate a property or assigng the contract.
Also known as due-on-sale clauses, they are standard in mortgages.
Such mortgage alienation clauses are found in residential or commercial property loans or financing agreements.
They ensure that the lender’s money will be fully paid in the event the real estate property is sold or if the borrower intends to transfer title to a third-party.
An acceleration clause is similar to an alienation clause whereby the lender can demand the debt’s full repayment.
Although you’ll need to see the specific terms of your acceleration clause, typically, when a borrower misses loan payments or defaults under the loan contract, the lender can demand the reimbursement of the debt, partially or in full, by a certain date.
Triggering the acceleration clause often leads to the lender attempting to foreclose the property.
The acceleration clause can be exercised in the lender’s discretion when the borrower defaults under the loan contract such as:
- Default on monthly payments
- Default in paying property taxes
- Not maintaining adequate insurance on the property
- Insolvency of the borrower
- Bankruptcy of the borrower
The term “acceleration” refers to the loan obligation becoming due prior to what was agreed under the loan contract.
At the end of the day, an alienation clause is a form of “acceleration” of the debt obligations as all of the debt becomes payable on the closing date of a property or contract transfer date.
In other words, if you sell your home where you still have an unpaid balance on your home loan, your lender will demand to ask for the immediate and full payment of the home loan before the title of your home is transferred to the buyer.
In some cases, a loan contract or mortgage will not have an alienation clause.
In other words, the borrower is not restricted or prohibited from transferring the loan contract to someone else when there is an alienation of title.
A mortgage without an alienation clause is called an “assumable mortgage”.
With an assumable mortgage, the property owner can transfer the mortgage to the buyer and sell or assign the title to the property without fully reimbursing the loan creditor.
From the moment the mortgage is transferred to the buyer, he or she will become responsible to make the ongoing mortgage payments to the lender.
John has a property with a $150,000 mortgage balance left to pay.
He finds a buyer who is willing to pay him in total $200,000 to purchase his house.
To close the transaction, John will transfer his assumable mortgage of $150,000 to the buyer along with the title to the property and the buyer will pay John $50,000 representing the difference between the purchase price and the outstanding mortgage.
With an assumable mortgage, a person can transfer the mortgage to another person.
In this case, the buyer will:
- Take over the mortgage without having to apply for a mortgage or financing
- Take over the mortgage balance and be responsible for it going forward
- Will assume the mortgage on the same terms and conditions as it was initially agreed with the initial borrower
- Will assume the monthly payments and interest rates as outlined in the mortgage
Alienation clause example
Let’s look at a few alienation clause examples to see how they are presented in contracts.
Example 1: Anti-alienation clause
Party A shall not, in any manner, alienate, sell, transfer, assign, pledge, encumber or charge, or attempt to alienate, sell, transfer, assign, pledge, encumber, charge or otherwise dispose of the Property.
Example 2: Alienation clause promissory note
In case the Borrower alienates, sells or assigns or intends to alienate, sell or assign the title to the Property, the full balance of the Loan shall become due and payable immediately with or without the Lender’s notice to the Borrower to this effect.
Alienation clause FAQ
What is alienation in real estate
An alienation provision or due-on-sale provision is a contractual language obligating a party (the borrower) to fully execute their financial obligations towards the other party (the lender) before the contract or underlying property can be sold or transferred.
The ultimate beneficiary of the due-on-sale provision is the lender.
In essence, the lender ensures that the borrower’s debt is settled before the contract is alienated.
When a real estate mortgage contract does not have an alienation clause, we consider that contract to be an assumable mortgage contract.
In other words, the borrower (mortgagor) has the right to transfer and assign the deed of mortgage to a third party (new mortgagor) who will “assume” or continue the initial mortgagor’s obligation in favour of the lender (mortgagee).
What is an alienation clause in a lease
An alienation clause in a lease contract works the same way as in a mortgage contract.
In the event of the alienation or transfer of the lease, the tenant agrees to execute its financial obligations in favour of the landlord.
For instance, the landlord may lend money to the tenant for leasehold improvements and include the repayment of this debt in the monthly rentals.
Should the tenant wish to terminate the lease or transfer it, the landlord can demand the full reimbursement of the borrowed sums.
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