What is a Due On Sale Clause?
How do you legally define it?
What are the essential elements you should know!
In this article, we will break down the legal definition of Due On Sale Clause so you know all there is to know about it!
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What Is A Due On Sale Clause
A due on sale clause (also known as an acceleration clause) is a contractual clause found in mortgage contracts whereby the borrower is required to repay the loan in full in the event of a transfer or sale of the property.
In other words, your loan is “due” or “payable” on the “sale” of the property.
It’s like your lender saying “if you sell your property or transfer it to someone else, I need all my money back”.
The objective of the mortgage due on sale clause is to protect the bank, lender, or creditor where they are assured that the borrower will not convey the loan to someone who may not have good credit or when the market interest rates are not favorable for the lender.
In essence, if a borrower has a mortgage on a property and intends to sell it, it must first discharge the mortgage, transfer the property with unencumbered title, and the buyer will then have his or her mortgage lender secure a lien against the property for a separate mortgage.
If a borrower attempts to sell the property without paying off the mortgage, the lender will have the ability to foreclose the property.
How do you define a due on sale clause?
What is the definition of a mortgage due on sale clause?
According to Investopedia, a due on sale clause means:
A due-on-sale clause is a provision in a mortgage contract that requires the mortgage to be repaid in full upon a sale or conveyance of partial or full interest in the property that secures the mortgage.
The main purpose of a due on sale clause mortgage or in real estate loans is to protect the lender.
The two main reasons why a lender will want protection is to ensure:
- It reduces its exposure to market interest rate fluctuations
- It can lend to the borrowers it chooses
Interest Rate Protection
The idea is for the borrower to pay back the lender’s mortgage on the sale of the property instead of selling the property to the new buyer and having the buyer “assume” the mortgage.
Imagine the lender issued a mortgage to a borrower at a 5% interest rate.
However, at the time of the sale of the property, interest rates are now at 10%.
If the buyer could assume the mortgage, the buyer will have a clear advantage of assuming the seller’s mortgage at a 5% interest rate than getting a new mortgage at 10%.
In essence, a due on sale clause protects the lender against this possibility of having to be “locked” in a below-market interest rate mortgage.
Another important reason why lenders prefer to have the borrower pay off the entire loan “on sale” is to ensure that they choose the borrower of their choice and configure the mortgage agreement accordingly.
In other words, the creditor will evaluate the risk based on the borrower’s profile and include or remove legal protections in the mortgage agreement, adjust the commercial elements, and consider the overall loan transaction when extending the mortgage.
In normal market conditions, the due on sale clause is triggered literally on a daily basis.
Whenever a person purchases a new home or real estate property, the seller’s mortgage is paid off in virtue of the “due on sale” provision and the new borrower’s lender registers a lien based on the borrower’s mortgage.
However, in some situations, the lender may legally enforce due on sale rights in the event of the breach of the mortgage terms or when the security may be potentially damaged.
If the lender triggers the enforcement of the due on sale provision, the borrower must fully pay the capital and accumulated interest on the loan.
Otherwise, the lender may have the option to foreclose the property and legally exercise its rights over it.
Are there exceptions with regards to the due on sale provision?
Under the 1982 Garn-St Germain Act, a lender is precluded from enforcing a due-on-sale clause in certain situations defined by statute.
Here are some Garn-St Germain Act due on sale exceptions:
- Divorce or legal separation where the ownership changes between spouses
- Transfer of property to children
- Transfer of a property to relatives of the borrower in the event of death
- Transfer of property to a living trust where the borrower is the beneficiary
- When a property is held in joint tenancy based on a joint tenancy agreement
Let’s look at an example of how the due-on-sale clause works.
Due on sale clause real estate
Imagine Mary purchased a home a few years ago for $250,000.
Today, she receives an offer of $300,000 from an interested buyer.
If she decides to sell, then the due-on-sale provision will kick in requiring her to pay off her mortgage.
Let’s assume she paid off $100,000 over the years and now has $150,000 still owing to the bank.
In this case, she will need to take $150,000 from the proceeds of sale and pay off the remaining balance of her mortgage and she can pocket the remaining $150,000.
When the loan is paid off, Mary’s lender will give her a lien discharge so she has a clear title to transfer to the buyer.
Due on sale clause transfer to LLC
The same concept applies to the transfer of a property from an individual to an LLC.
If Mary has a property in her name and wishes to transfer the ownership of the property to an LLC, then the clause due on sale may get triggered.
Although there are some legal exceptions outlined in the Garn-St Germain Act, if Mary cannot fit into the legal exceptions, her lender may require the full reimbursement of the loan.
So, what is Due On Sale Clause?
Let’s look at a summary of our findings.
Due On Sale Clause
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