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Watch Out For the Due-on-Sale Clause

Any time you transfer real property, you need to watch out for the due-on-sale clause.  If your lender wishes, they could call your loan to be due at the time of transfer in order to force you into a new, higher interest rate.

The governing law for the due-on-sale clause is the Garn St. Germain Act. Under the act, due-on-sale clauses are legal with some exceptions as to when a due on sale clause can be triggered. The list of exceptions is as follows:

  1. The creation of a lien or other encumbrance subordinate to the lender’s security instrument which does not relate to a transfer of rights of occupancy in the property;
  2. The creation of a purchase money security interest for household appliances;
  3. A transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety;
  4. The granting of a leasehold interest of three years or less not containing an option to purchase;
  5. A transfer to a relative resulting from the death of a borrower;
  6. A transfer where the spouse or children of the borrower become an owner of the property;
  7. A transfer resulting from a decree of a dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement, by which the spouse of the borrower becomes an owner of the property;
  8. A transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property; or
  9. Any other transfer or disposition described in regulations prescribed by the Federal Home Loan Bank Board.¹

There is no exception for the transfer of a mortgage into an LLC.  A person seeking to transfer a mortgaged property into an LLC can request permission to do so from the bank. Banks have little reason to not allow the transfer since interest rates have not increased much, but make sure to get the banks permission in writing. There is no statue of limitation for enforcement of a due-on-sale clause after the transfer of a mortgaged property into an LLC, so a bank can wait till interest rates have gone up several years down the road and then enforce the clause.

Note that the all-too-popular land trust schemes run afoul of this law. Hundreds of thousands of properties have been put into land trusts where an LLC is the beneficiary.  According to exception 8 above, the trust must remain revocable. If and when the land trust owner sells any shares of the land trust to others, the due-on-sale clause is triggered and the lender has the right to call the loan.

Since the Act was passed, interest rates have trended to stay the same or decreased. As long as interest rates have decreased there is no incentive for banks to enforce due-on-sale clauses.

It is possible to make a weak legal argument that the Garn St. Germain Act does allow for an exception for a transfer of a mortgage property into an LLC. The purpose for the exceptions is to provide protections for the consumer where the enforcement of the due-on-sale clause would be inequitable. Since the individual who received the mortgage and note is still liable to the bank for the mortgage and note even if it is transferred into that individual’s LLC, it could be argued that the bank is not harmed in any way and that the enforcement of the clause would be inequitable. However, the only case that even mentions a due-on-sale clause with relation to a transfer into a LLC is Baldwin v Wells Fargo Bank in the United States District Court, Oregon. The bank tried to enforce the due on sale clause in order to try and cover for the way they treated the person who had transferred the property into an LLC. The court ruled that the due-on-sale clause was triggered and explained that their reasoning was because the other party could not produce any legal argument as to why the clause should not be applied. So don’t rely on it.

Interest rates have been so low for so long that there is only one direction for them to go.  When they start to rise, expect that these due-on-sale clauses will be enforced a lot more and plan for your business accordingly.

  1. If I am understanding this correctly, I can essentially add my name to the deed of a property currently owned solely by my wife via the courthouse filing of a new tenancy-by-the-entirety to replace the current deed? And this will not trigger the due-on-sale clause?

    Do I also have to add my name to the mortgage? At the time, I chose not to include my name on the property or mortgage and they had me sign a document to waive my homestead exemption rights.

    • The transfer to a spouse is an exemption. You shouldn’t put your name on the mortgage. You can transfer your house to me and I don’t have to put my name on the mortgage. I assume you are doing the tenancy by the entirety to get asset protection. If you are in Florida or Texas, you already have asset protection under the homestead acts.

    • Again, this situation would fall under exception #6. The interest is being transferred to a spouse. As for the mortgage there is no requirement that the spouse being added to the title has to also be on the mortgage.

  2. Lee,
    This is good to know. There is a very famous guru who constantly teaches that you can take over property “subject to” and don’t worry about the due on sale. He also says to do the closing with an attorney. I’d like to find an attorney who would allow this with the due on sale clause in place. Doesn’t this make taking title “subject to” illegal?

    • Fred,

      Due on sale clauses were specifically created to deal with “subject to” sales. It is not a way around the due on sale clause. Currently banks are to worried about enforcing due on sale clauses because interest rates are so low but there is no statute of limitation on enforcing it and as soon as rates go up there is going to be a surge in banks going after people who have sold property subject to the due on sale clause.

  3. Does exemption 6 apply if mortgage is under wife and husband, but wife quitclaims deed to husband?

  4. I included my property (had a 1st and 2nd on it) in a chapter 7 many years ago. No mortgages where re-affirmed and I have been giving the holder of the 1st some money so as not to foreclose (1st mortgage is less than the property value so if 1st foreclosed they can be paid fully). The property is still underwater with respect to 1st+2nd though. Rental prices are such that i can rent the property for more than the operating costs of the property. Can I transfer the property to an LLC without:

    a) Notifying any bank; and
    b) Can any bank trigger a due on sale clause with the knowledge i have no legal obligation to pay them anything.

    • James,
      If you transferred the property to an LLC the bank can still trigger the due on sale clause and foreclose on the property. They may not be able to get a default judgement against you, but they can still get the value of the house out of it.

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