One thing’s for sure, buying a home is an involved undertaking. And if you’re getting a mortgage or deed of trust to purchase a new home, it gets even more involved. There are all kinds of legal aspects to be aware of, including the due-on-sale clause that most mortgages contain.
A due-on-sale clause is a part of a mortgage loan contract that requires the borrower to repay the remaining loan balance in full to the lender when the property is sold.
But what does this mean exactly? And how does it impact you as the home buyer? We will help you with all you need to know about the due-on-sale clause. Then you’ll be well-informed and better set up for success in your home buying journey.
Due-on-Sale Clause Basics
If you are getting a mortgage to buy a home, your contract will probably include a due-on-sale clause that the lender added. The due-on-sale clause (also called an alienation clause), lets a lender demand that your remaining mortgage balance be paid in full when you sell or transfer ownership of the home.
“Demand” sounds harsh, like the lender will come stomping to your front door with an angry face. But this is not how the due-on-sale clause plays out. In reality, they are a rather hum-drum part of the normal process of selling your home when you still owe money on the mortgage.
What is a due-on-sale clause?
Simply put, a due-on-sale clause means that if you sell your home or transfer it to someone else, you need to first pay what you still owe on the home’s mortgage.
How do you do this? When you sell your home, the buyer typically takes out a new mortgage. Then, part of the proceeds from the sale goes to pay off your existing mortgage.
The due-on-sale clause makes sure this payment happens.
Why do lenders put a due-on-sale clause into a mortgage?
The due-on-sale clause protects the lender by making sure the new buyers of the home don’t assume (or take over) the existing mortgage. Opportunities to take over an existing mortgage are limited. More about that shortly.
This prevents the new buyers from possibly getting a below-market mortgage rate instead of a higher rate where the lender makes more money. It also protects the lender against the risk of having a buyer who is less likely to repay the loan and hasn’t been thoroughly vetted.
Do all mortgages have a due-on-sale clause?
The majority of mortgages in the United States have a due-on-sale clause. The main exceptions to the due-on-sale norm are mortgages backed by the government, like Department of Veterans Affairs (VA) or Federal Housing Administration (FHA) mortgage loans.
Due-on-Sale Mortgage vs. Assumable Mortgage
A mortgage loan with a due-on-sale clause is sometimes referred to as a due-on-sale mortgage. This differentiates it from an assumable mortgage loan.
An assumable mortgage is where the buyer takes on the seller’s remaining mortgage debt. That is, instead of getting a new mortgage to purchase a property, the buyer assumes responsibility for the existing mortgage with its terms, rate, schedule and payments.
History of the Due-on-Sale Clause
How did the due-on-sale clause come about? We’re glad you asked.
Let’s go back to the ancient history of the early 80s, when playing Asteroids and wearing shorts with whales all over them weren’t the only things that were de rigueur. The trends of the era also included high mortgage interest rates that hovered just over 18% in 1981.
When interest rates get too high, buyers can easily be priced out of the real estate market, so fewer people purchase homes.
Also, many mortgages at this time were assumable mortgages, which are risky for the lender and also cuts them off from the opportunity to sign the new buyer up with a new mortgage.
In 1982, the Garn-St. Germain Depository Institutions Act. was passed to help revive the housing market. Among other things, the act made the due-on-sale clause, as well as exceptions to the clause, federally enforceable.
A due-on-sale clause helps strengthen the housing market by assuring lenders that they’ll get the full return on the money they invested, which they can then re-lend. Before the act, mortgage loans were largely assumable.
It also pretty much guarantees that new buyers take out a new mortgage, which can be at a potentially higher mortgage rate. Whether the rate is higher or not, this ensures that the mortgage is based on current market interest rates.
How a Due-on-Sale Clause Works
So how does the due-on-sale clause work? Ultimately, it’s up to the lender to enforce the due-on-sale clause, which is usually done during the real estate closing process. The seller uses the buyer’s (or the buyer’s lender’s) funds to pay the outstanding principal and interest on the mortgage.
If the seller tries to transfer the mortgage, such as through a quitclaim deed, or otherwise sell the house without the lender’s consent outside of certain permitted transfers, the lender can foreclose on the home.
Avoiding a Due-on-Sale Clause
You can avoid the due-on-sale clause in a few ways, including transferring your property to your children or setting up a living trust. Here are some examples of when a lender legally cannot enforce the clause, and when they may not want to.
When lenders cannot enforce
According to the Garn-St. Germain Act, there are several situations where a lender cannot legally enforce a due-on-sale clause, including:
- Divorce or legal separation: One spouse agrees to take sole responsibility for remaining mortgage payments.
- Transferring property ownership to children: Children living in the home may assume the mortgage.
- Transferring property to relatives after the borrower’s death: The person inheriting the property must be currently living in the home or will be living in the home.
- Transferring property to a living trust: Enforcement of the clause is not allowed if the person to whom the property is transferred is living in or planning to live in the home.
- Assumable Mortgage: If the mortgage was created as an assumable mortgage without the due-on-sale clause, there is no such clause to enforce.
In cases where the party taking over the loan is a successor in interest (like the first four bullets above), they can take over the mortgage payments without having to meet any particular requirements. In the case where the mortgage is assumable, but the party is not a legal successor, the lender can set their own requirements. For example, they may have minimum credit guidelines or the loan may have to be a certain age before assumption.
When lenders might not want to enforce
Lenders may also choose not to enforce a due-on-sale clause, such as in the situations below:
- If interest rates are lower than when the property was purchased: Assuming a mortgage with a higher interest rate than current loan rates may be okay with the lender if the new buyer is deemed to be a good risk.
- If the home has significantly declined in value: The lender would probably make more money with the current mortgage loan of a higher-value property than with a new one on a home of less value.
- If you ask: Sometimes, asking the lender may be enough to convince them to not enforce the clause.
The Fine Print
The due-on-sale clause is pretty standard in mortgage contracts today. But if you are looking for a home and have questions about the clause, talk to your lender, and feel free to seek out a real estate attorney for legal advice.
Freddie Mac. “30-Year Fixed Rate Mortgages Since 1971.” Retrieved February 2022 from https://www.freddiemac.com/pmms/pmms30
Federal Reserve History. “Garn-St Germain Depository Institutions Act of 1982.” Retrieved February 2022 from https://www.federalreservehistory.org/essays/garn-st-germain-act
Cornell Law School, Legal Information Institute. “12 US Code § 1701j–3 – Preemption of due-on-sale prohibitions.” Retrieved February 2022 from https://www.law.cornell.edu/uscode/text/12/1701j-3