A due-on-sale clause — also known as an alienation clause — is wording commonly found in the fine print of a mortgage agreement. It allows lenders to enforce being repaid for the balance of a home loan when the property is either sold or, in some instances, transferred to another owner. That’s a simple explanation, but there is more to it so let’s dig a bit deeper.
What Is a Due-on-Sale Clause?
Understanding how home loans work is an important part of the home-buying process. Here’s what to know about a due-on-sale clause before you sell or purchase a home:
Definition and Purpose
A mortgage due-on-sale clause or alienation clause requires that the loan be paid in full when the home is sold. You may have heard about assumable mortgages becoming more popular as a way for buyers to sidestep higher interest rates by taking over a seller’s mortgage at a lower-than-typical rate. The due-on-sale clause prevents one buyer’s mortgage from being assumed by whoever purchases the house next.
Lenders began using due-on-sale clauses in the 1970s as interest rates spiked and buyers assumed the seller’s loan instead of applying for a new one with a higher rate. While homeowners won several court battles against this rule during the time, the U.S. Supreme Court ultimately ruled in favor of the banks. Congress formally legalized the due-on-sale clause for mortgages with the Garn-St. Germain Federal Depository Institutions Act in 1982.
Where It’s Found in Mortgage Documents
A due-on-sale clause should be located in your loan agreement. If you can’t find it in your paperwork, it’s worth calling your lender, especially if you plan to sell your house soon. Most, if not all, conventional loans are not assumable, meaning there should be a due-on-sale clause in place.
Some mortgages are assumable, and don’t have this type of clause in the loan agreement. Assumable loans include:
• FHA loans backed by the Federal Housing Administration
• VA loans backed by the U.S. Department of Veterans Affairs
• U.S. Department of Agriculture loans
Remember, though, that even if a loan is assumable, the new borrower still needs to qualify for the loan. In many situations, however, they don’t have to go through the whole mortgage process. They simply get to assume the existing mortgage from the original owner. Also note that there are unique FHA flipping rules that you may need to be aware of if purchasing a home that has been owned by the seller for a brief time is a part of your plan.
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Recommended: Choosing a Mortgage Term
How the Due-on-Sale Clause Works
Now that you understand what an alienation clause or due-on-sale clause is, find out how it works so you can avoid lenders invoking this portion of your loan agreement.
Triggering Events
Lenders are notified when ownership of a property securing a loan is transferred. If the seller doesn’t automatically pay off the loan balance at closing, the lender may choose to invoke the due-on-sale clause.
There are a few other situations that would cause a lender to invoke the due-on-sale clause. These include:
• Transferring the property to a family member without a death or divorce
• Transferring the property into an irrevocable trust
• Transferring the property into a lease of more than three years
• Changing ownership from a personal property to an LLC or vice-versa
• Creating a junior lien that would lower the lender’s stake in a property
Lender Rights and Actions
In these cases, the lender could require the recipient of the property to transfer the title back to the original owner. The recipient usually has a set amount of time to do this, such as 30 days.
Another option for lenders, however, is to foreclose on the home if the original borrower is unable to provide the remaining mortgage balance. In these situations, refinancing the property or possibly modifying the original loan are also possibilities. (To see how much your monthly payment would likely be after a refinance, use a mortgage calculator.)
Impact on Property Transfers
The due-on-sale clause makes it more difficult to transfer properties to new owners. After the Supreme Court ruling, those recipients must meet certain criteria. Plus, even if they do meet the criteria, they must still qualify for the loan.
Exceptions to the Due-on-Sale Clause
There are exceptions that cause the due-on-sale clause to not take effect. Those exceptions are:
• Divorce: If the original borrower loses the house in a divorce settlement, the due-on-sale clause should not go into effect.
• Inheritance: Should the primary borrower die, then their children or surviving spouse can inherit the house without triggering the due-on-sale clause. With the average mortgage length being 30 years, it’s understandable that unique rules had to be put in place to account for buyers dying before their mortgage was fully paid.
• Joint tenancy: If two or more people jointly own a property, then the death of one owner doesn’t trigger the due-on-sale clause. Instead, whatever portion of the property was owned by the deceased borrower is transferred to the other remaining borrowers.
• Living trust: When a property is transferred to a living trust, there are no legal ramifications. A living trust is when a trustee is designated by a property owner to manage an estate.
Implications for Buyers and Sellers
If you’re the seller, the due-on-sale clause simply means that whatever money you make in the sale of your house must be adequate to satisfy your remaining loan balance. If it doesn’t, you have to be able to pay off your remaining mortgage obligations with other funds.
For the buyer, the implication of the due-on-sale clause is that the seller will have a minimum price that needs to be met in order for them to sell the home. The original lender must receive the amount it is due, or the house will not be free and clear for sale.
Fortunately, the desire to transfer an existing mortgage to a new borrower who is unrelated to the seller doesn’t happen very often.
Legal Aspects and Enforcement
It’s important to remember that there are situations where the due-on-sale clause cannot be invoked. As noted above, a title transfer that occurs because of a divorce or death usually forbids lenders from seeking immediate repayment. And even if lenders are within their rights, they still must provide ample notification before invoking the due-on-sale clause.
Recommended: Active Contingent in Real Estate: What You Need to Know
The Takeaway
The due-on-sale clause (or alienation clause) limits who can take over an existing mortgage from a homeowner, and it essentially establishes a minimum sales price that a buyer would have to meet in order for a seller to be able to agree to a contract. This is because lenders must always receive any remaining money owed on a mortgage when a home is sold.
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FAQ
Can I transfer my property without triggering the due-on-sale clause?
It depends on the situation, but there are some situations where it can be done, depending on the original loan agreement. For example, it’s often possible to transfer a property during a divorce, and it’s also possible to transfer the property to an immediate family member after the death of the primary borrower.
What happens if I violate the due-on-sale clause?
If you violate the due-on-sale clause, the biggest thing that can happen is that your lender can demand immediate full repayment of your outstanding loan balance. If you are unable to pay, then you are at risk of foreclosure, which can damage your credit score for seven years.
Are there any mortgages without a due-on-sale clause?
It’s rare to find a conventional mortgage without a due-on-sale clause because it’s in the lender’s best interest. However FHA, VA, and USDA loans typically don’t have this clause.
Photo credit: iStock/Perawit Boonchu
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