A due on sale clause is a provision in a mortgage agreement imposed by lenders that requires borrowers to pay off the full principle balance of the loan upon the sale or transfer of a property. Lenders do this to protect their investment by being able to recoup their debt simultaneous to the property owner selling the property or obtaining a new loan in replacement of the original loan.
Another reason why lenders typically require borrowers to have a due on sale clause is so that borrowers cannot transfer the mortgage to another party with the intent of the other party assuming the below current market interest rates.
Borrowers do not have the right to transfer the mortgage to another party, even if the other party happens to be a buyer who wishes to assume the mortgage. While sellers can provide a wrap around mortgage, whereby the seller collects payments from the buyer, they do not have the ability to transfer the mortgage without paying off the mortgage.
In the event a borrower transfers their mortgage to another party without the approval of a lender, the lender could potentially initiate the foreclosure process or force the borrower to come due on the full principle balance.
Reasons a Lender May Not be Able to Impose Due on Sale Clause
There are instances when a lender cannot impose the due on sale clause, even if the clause exists in the mortgage provision. This occurs when a borrower settles a divorce and one of the unnamed spouses on the mortgage takes over the property or when the borrow of record dies and the property transfer to a spouse or the deceased party’s children. This might also occur when the property is going to a trust whereby a beneficiary exists.
A lender’s inability to impose their agreed upon due on sale clauses began in 1982 through the Garn-St. Germain Act, where the act permitted certain events such as those described in the paragraph above to be exempt from the due on sale clause.
Due on Sale Clause History
The overwhelming majority of all loans utilize due on sale clauses when the loan is being used to secure financing for a property. In the past many mortgages were assumable, meaning they could be assumed by a party other than the one who initially got the financing. To lower the risk of foreclosure from a party that may have a low credit score or income, lenders imposed this clause so that only the original party can retain the mortgage.
Prior to 1982, state law dealt with issues relating to mortgage provisions, and state law typically allowed borrowers to transfer loans to other party’s however after 1982, federal law permitted lenders to require borrowers to pay the full principle balance of the loan.
