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- What is a Due on Sale Clause?
- How Does a Due on Sale Clause Work?
- When the Due on Sale Clause Is Enforced
- Advantages of a Due on Sale Clause
- Disadvantages of a Due on Sale Clause
- Exceptions to the Due on Sale Clause
- How a Due on Sale Clause Impacts Real Estate Investing
- How to Avoid the Penalties of a Due on Sale Clause
- Due on Sale Clause Example
- Due on Sale Clause: Frequently Asked Questions
- The Bottom Line: Due on Sale Clause
What is a due on sale clause?
Many experienced real estate investors shudder in fear when they hear the phrase "due on sale." They worry that, in a worst-case scenario, this kind of contractual language can leave them liable for a huge sum of money upfront, even before they've had a chance to rent out or renovate their property.
If you’re a beginner real estate investor, you may be wondering what a due on sale clause is — and whether or not real estate investors are justified in being scared of them.
In this article, we’ll break down:
- What a due on sale clause — also called an acceleration clause — is
- How to avoid the penalties from a due on sale clause
- A due on sale clause example
- Frequently asked questions associated a due on sale clause
If you’re ready to learn everything you need to know about a due on sale clause, let’s get started!
What is a Due on Sale Clause?
A due on sale clause — also called an acceleration clause — is a stipulation written into the majority of mortgage agreements.
It says that when the borrower transfers a property title to another party before getting consent from their lender, their existing mortgage balance will be due immediately and payable in full.
In the past, it was common for a new buyer to just assume the balance of the mortgage due from the old owner. This bothered some lenders, because the new owner may not have qualified for the interest rates applied to the old mortgage.
Lenders felt that this put the mortgage at greater risk of default.
In 1982, Congress passed an act to allow for the creation of the due on sale clause in mortgages and deeds of trust.
How Does a Due on Sale Clause Work?
Again, if it’s invoked, the outgoing owner must pay off the entire mortgage. That’s why it’s a source of concern for real estate investors.
In the case of a due on sale clause, the new owner must negotiate a new mortgage with the lender, presumably with a different interest rate.
When the Due on Sale Clause Is Enforced
Most mortgages issued in the United States have a due on sale clause to protect the lender.
The due on sale clause states that you must pay off your mortgage when you sell or transfer your property.
If you don’t, the lender can foreclose on the property and take possession.
If there is no due on sale clause, the mortgage is assumable. Instead of buyers applying for a mortgage, they take on the seller’s mortgage with the existing interest rate and outstanding principal.
The due on sale clause is triggered when the property is sold and the borrower must then pay the entire loan balance to the lender.
Advantages of a Due on Sale Clause
There are advantages to a due on sale clause — for the lender.
The due on sale clause protects the lender from a buyer who is unlikely to repay the mortgage.
It ensures that buyers will apply for a mortgage at the going rate, rather than assuming a mortgage with a low rate.
The due on sale clause also guarantees that buyers will not be able to assume a mortgage they are unqualified for.
Disadvantages of a Due on Sale Clause
There are disadvantages of a due on sale clause for the buyer.
With a due on sale clause, the buyer cannot assume a mortgage from the seller that may have a lower interest rate than the current rate.
If the previous owner holds a mortgage at 4%, the current mortgage rate is 6% and the buyer can assume the existing mortgage, the mortgage company is losing out.
Also, there is a risk to the buyer that they will not be able to obtain a mortgage at all.
The creditor will look at factors like income, debt, and credit scores to determine if the buyer is a good risk — or not.
Exceptions to the Due on Sale Clause
If the new titleholder acquires their property through specific means, the due on sale clause, or acceleration clause, can't be invoked if the new owner lives at the property in question. This includes:
- legal separation
- by having it transferred into a living trust
- legal separation
- by having it transferred into a living trust
- Transfer of the property to children
- Transfer of the property to relatives of the borrower in the event of death
- When the property is held in joint tenancy
If the new titleholder doesn't live on the premises, the due on sale clause can be activated, which would mean that the new owner would have to pay off the balance immediately.
Next, we’ll look at how a due on sale clause, or acceleration clause, impacts real estate investing.
How a Due on Sale Clause Impacts Real Estate Investing
When an investor buys a property that they intend to rent out, they may take out a residential mortgage and then transfer the title to a limited liability company (LLC).
Doing so gives them:
- greater security
- enhanced legal protections
However, the lender may only see that the title has been changed without their consent.
This could legally trigger the due on sale clause or acceleration clause.
All of a sudden, the investor would be liable for the entire amount of the loan on the property they had just purchased.
If they couldn’t come up with the balance, the lender could legally foreclose on the property.
With that said, in the real world, most lenders don’t mind if a private investor transfers the deed to an LLC that they own and operate.
Generally, this won’t be seen as a reason for the lender to invoke the due on sale clause.
A lender is more likely to invoke a due on sale clause if the owner is far behind on payments. Keep in mind that if the real estate investor is reputable, and given the effort that a lender will have to undertake to begin the foreclosure process, invoking a due on sale clause wouldn’t be worthwhile for the lender.
Next, we’ll look at how to avoid the penalties of a due on sale clause, or acceleration clause.
How to Avoid the Penalties of a Due on Sale Clause
If a due on sale clause is invoked, and the real estate investor cannot pay off the mortgage in full, they have two options:
The investor could negotiate for a refinanced mortgage. This would create a new agreement, most likely with different interest rates.
Asset Protection Trust
Some owners transfer their titles into asset protection trusts (APT) to protect themselves from creditors and litigation over their properties.
In this case of an asset protection trust, the lender can’t invoke a due on sale clause.
Due on Sale Clause Example
Let’s look at an example of a due on sale clause
Let’s say Maria has owned a home for 13 years and has 17 years remaining on her mortgage agreement. Because of financial problems, she’s far behind on her mortgage payments.
She sells the home to a fix-and-flip investor named John.
The lender learns of the sale and invokes the due on sale clause. Maria then becomes responsible for paying off the loan balance immediately.
When the sale closes, Maria uses the proceeds to pay off the old mortgage.
John, the new owner, negotiates his own mortgage agreement on the property.
If he decides to transfer the title to an asset protection trust, the lender cannot activate the due on sale clause.
If John transfers the title to an LLC, the lender can invoke the clause. But in most cases, it’s not worth the lender’s time and trouble to do so, especially if John is a highly qualified investor.
Due on Sale Clause: Frequently Asked Questions
Next, we’ll look at some of the most commonly asked questions with a due on sale clause.
Q. Do All Mortgages Have a Due on Sale Clause?
Most mortgages do, but not all of them.
Q. Acceleration clause, alienation clause, due on sale clause…are these all the same?
They aren’t all the same. Many real estate investors can confuse these terms. Here are the differences:
- Acceleration Clause: The acceleration clause in a mortgage says that the entire debt is due immediately if the borrower defaults on the loan.
- Due on Sale Clause: This clause requires the borrower to pay the entire loan balance when the property is sold.
- Alienation Clause: The alienation clause is another name for the due on sale clause. It requires the borrower to pay the entire loan balance when the property is sold.
Q. When Does the Lender Not Invoke the Due on Sale Clause?
The lender has the discretion to invoke the clause.
Simply put, if they don’t think they’ll negotiate a better deal with the new owner, they may opt-out of invoking it if legal foreclosures are not worth the effort.
Q. How Does a Due on Sale Clause Affect Seller Financing?
A due on sale clause makes it a little harder to offer to finance a new owner’s mortgage.
To avoid a due on sale clause, the new agreement must be well-structured.
It’s recommended that you only sell your mortgage note to a highly qualified investor if you plan to offer seller financing.
Q. How Does a Due on Sale Clause Affect Wholesaling?
Since a wholesaler is not technically the buyer or the seller — just the contractor finding a seller — due on sale clauses don’t apply to them.
They pocket the profits of a sale after they’ve paid off the old owner.
However, if you as a real estate investor are buying a contract, keep in mind that the loan can legally be called due.
Q. What Happens if a Borrower Sells or Transfers the Property Without Informing Their Lender?
The lender may choose to foreclose on the property, especially if the buyer is not a highly qualified one. But again, many lenders don’t see this as a fruitful option.
The Bottom Line: Due on Sale Clause
While the due on sale clause or acceleration clause should never be ignored, real-world evidence suggests that real estate investors shouldn’t live in fear of the due on sale clause.
Provided they remain in good standing with the lender and keep up with regular payments, the chances of a lender invoking the due on sale clause are fairly remote, allowing you to focus your time and energy on growing your real estate business.