Since 1982, almost all real estate loan contracts between individuals and institutional lenders have included a due on sale clause. The clause states that if a seller transfers any interest in real property to another individual or individuals, the lender may, at its sole discretion, require the entire loan balance to be paid. Including the clause is not a legal requirement, but enforcement of the clause is controlled by federal law.
The due on sale clause prevents a buyer from simply assuming the loan of the seller. Prior to 1982, this was a popular sales method. Assuming the loan was particularly advantageous if the seller’s loan was at a lower interest rate than the rate available at the time of the transaction. It also allowed the buyer to avoid a credit check.
Situations where the due on sale clause does not apply.
- The property can be put in a trust under the owner’s name if the owner still occupies the property and is one of the beneficiaries.
- Transfer of the property to a spouse as part of a property settlement.
- Transfer of the property to a relative upon the death of the owner.
Consequences of violating the due on sale clause.
Violating the clause is a contract issue, not a criminal offense. But, depending on the wording of the loan documents, there may be an issue of fraud for a person who lied on any loan documents.
- If the clause is enforced and the loan is called, unless the buyer or seller pays off the loan, the lender will foreclose and the foreclosure will go on the seller’s credit record.
- There may be a prepayment penalty causing the seller an additional financial burden.
- The buyer will lose any money invested in the property and be evicted.
Frequency of banks enforcing the due on sale clause.
The truth is that lenders are not anxious to enforce the clause as long as they continue to receive timely payments on the loan. In today’s economy where there is a backlog of properties in foreclosure, if lenders are receiving their money, they are not likely to add another foreclosure to their workload.
The likelihood of enforcement increases when interest rates go up. Lenders are not happy to maintain a low interest rate for an owner that did not qualify for the original loan.
There are situations where the lender agrees to a loan assumption and agrees not to enforce the due on sale clause. Lenders basically want to know who is responsible for the loan and when it will be paid.
Those are the basic facts! To learn how to manage the risks of the due on sale clause inside of your investing business and capitalize on more deals, the details of this investment strategy have been laid out for you here.