Understanding The Due On Sale Clause On Your Home Mortgage
Cory Shrader
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Article Title:
==============
Understanding The Due On Sale Clause On Your Home Mortgage
Article Description:
====================
The Due On Sale Clause is among the most frequently misunderstood
and most-feared legal terms in American contractual law. In this
article, we are going to take a look at what it is, what it is
not, and how to avoid violating it.
Additional Article Information:
===============================
1835 Words; formatted to 65 Characters per Line
Distribution Date and Time: 2009-02-04 12:00:00
Written By: Cory Shrader
Copyright: 2009
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Understanding The Due On Sale Clause On Your Home Mortgage
Copyright (c) 2009 Cory Shrader
Liberty Home Sellers
http://www.libertyhomesellers.com/
The "Due On Sale Clause" is among the most frequently
misunderstood and most-feared legal terms in American contractual
law. In this article, we are going to take a look at what it is,
what it is not, and how to avoid violating it.
What Is The Due On Sale Clause?
On nearly every home mortgage and loan contract written in the
United States, the Due On Sale Clause is one of those fine print
inclusions that a lot of home buyers overlook.
In essence, the Due On Sale Clause is a legal term that means
that if a mortgage holder transfers interest in a real property
to a third-party, then the bank or other lender has the "right"
to call the loan "due in full", and if the mortgage holder
cannot pay the loan in full at that time, the bank has the right
to foreclose on the property.
It must be noted however that many banks and lending institutions
do not enforce their rights in association to the Due On Sale
Clause. Banks and lending institutions are "not required" to
enforce the Due On Sale Clause, but they have the "right" to do
so at their discretion.
Understanding The Foreclosure Process
This is an area that most consumers simply do not understand. In
fact, just ten years ago, even I believed that if a home were
foreclosed, the bank would hold the property until they could
sell it at its full retail value.
But the truth is that banks and lending institutions generally do
not make money when they foreclose a property. Instead, most
banks will lose tens of thousands of dollars if they are forced
to foreclose on a property.
Here is the reason why.
When a bank forecloses a property, they cannot afford to have
non-performing real estate on their books. Banks and lenders also
borrow money and have debts to service. So a piece of real estate
on their books that is not generating an income is contrary to
the lenders business model.
As a result, when banks foreclose on a property, they need to
sell that property quickly. Foreclosed properties are sent to a
sheriff's sale, usually within 90 days of the completion of the
foreclosure process.
Now, here is where we get into the dollars and cents of why your
lender is going to lose tens of thousands of dollars when they
are forced to foreclose your property. The average property sold
at a sheriff's auction will only generate 20- to 40-cents return
against the retail value of the property!
So, if you have a 40% equity stake in your home at the time of
foreclosure and your bank will only be able to collect 20% to 40%
of the homes' retail value at auction, your bank is still going
to lose 20% to 40% of the retail value of the property at
auction. If your home is worth $100,000, you will lose your 40%
equity in the property or $40,000, and your bank will lose 20% to
40% of the retail value of the property or $20,000 to $40,000
when they sell your home at auction.
When you begin to understand why a bank or lender would not want
to foreclose your home, then you begin to understand why a bank
or lender may choose not to exercise its rights under the Due On
Sale Clause.
The History Of The Due On Sale Clause
The Due On Sale Clause began to work its way into mortgage
contracts during the 1970's. Homeowners who took loans in the
1950's and 1960's were getting really low interest rates on
home loans. But, during the 1970's, interest rates began to
spiral upwards.
Home sellers who were willing to entertain "creative financing
alternatives" to sell their homes began to sell their homes to
other parties through Contract For Deed arrangements. This
enabled buyers to avoid going to the bank to get new loans, which
would require a much higher interest rate than the rate the
current homeowner was paying on the home.
The math was easy to follow. The existing homeowner was paying 2%
to 4% interest on his or her mortgage. Buyers getting new loans
would be paying 8% to 16% to buy the same house. Assumable
mortgages were a clear winner for homebuyers, due to the higher
interest rates on new loans, and they were a clear winner for
home sellers who would be able to sell their homes more quickly
to motivated buyers.
Banks viewed the Due On Sale Clause as a method to force buyers
into a higher interest rate. So banks began to include the Due On
Sale Clause on all mortgage contracts.
Early on, a few states sided with buyers who felt that the Due On
Sale Clause was tantamount to predatory lending practices. So in
the late-1970's and early-1980's, state governments began to
outlaw the Due On Sale Clause.
However, the federal government sided with the banking and
savings and loan industries and passed a law in 1982, The
Garn-St. Germain Depository Institutions Act of 1982, that made
the Due On Sale Clause legal in all fifty states - with a few
exceptions defined by the legislation:
(http://www4.law.cornell.edu/uscode/html/uscode12/usc_sec_12_00001701---j003-.html)
The Garn-St. Germain Depository Institutions Act of 1982
Exceptions
As with any document filled with legalese, the language can be
somewhat confusing, leaving room for interpretation in the law.
As a result, many real estate investors operate on the fringes of
this legislation, doing things that some people consider legal
and other people consider illegal.
In the 27 years since this legislation was passed, the federal
government has not taken steps to clarify any of the ambiguity in
the legislation. As a result, it is entirely possible to find
lawyers who argue for each side of the specific interpretation of
the legislation.
Although some elements of this legislation remain ambiguous, some
elements of the legislation are crystal clear. (As always, you
should consult with an attorney before signing any contract.)
One point that is crystal clear is that any loan written on a
manufactured home (mobile home) cannot include a Due On Sale
Clause. All loans made on a manufactured home may be assumed by a
third-party. Vanderbilt Mortgage, one of the largest lenders on
manufactured homes, makes the process super easy. They will send
you a credit application for your buyer, and if the person passes
credit check, that person can take over your home loan
immediately under whatever terms you set.
Another exception includes the ability to sign a lease of up to
three years, so long as that lease does not include an Option To
Buy.
Allowances for an exception to the Due On Sale Clause have been
included to reflect the possibilities of the death of a borrower
or a couple getting a divorce.
One more important exception to the Due On Sale Clause has to do
with Inter Vivos Trusts. Also called a Living Trust, the Inter
Vivos Trust is a legal instrument that permits the transfer of
the ownership of the property from the individual to a legal
trust, managed by a trustee and held by the homeowner as
beneficiary. This was important to note, because many real estate
investors use this as a tool to protect the interests of the
buyer and seller in the real estate transaction.
If you want to know all of the specifics of this legislation,
please refer to the Cornell Law URL included above.
The Due On Sale Protects The Lenders' Interests
Although banks and lending institutions have the "right" to
enforce the Due On Sale Clause, most lending institutions will
not exercise that right.
Some of the ambiguity that accompanies the legislation regarding
the Due On Sale Clause is whether a borrower is required to
notify his or her lender of a transfer of interest in a property.
While it is fraud and a crime to mislead your lender, some argue
that if you don't tell your lender, then you will have
circumvented the legal ramifications of violating the Due On Sale
Clause. After all, if you don't lie to your lender, then you
have not committed any fraud.
The people who take this approach also believe that if the lender
never figures it out, then nothing is lost if the buyer continues
to make all of his or her payments on time every month.
Personally, I prefer that you play straight with your lender. As
someone who buys homes that have a mortgage, it is in my best
interest also, if the lender is aware of our intent to do a
transaction. I would hate to buy your house under contract, pay
on that house for one payment or dozens, and then have your
lender discover that you did not tell them that I was buying your
house. If your lender calls the Due On Sale Clause after I have
worked out a purchase deal with you, then that would be a pain in
my you-know-what.
Some lenders will not hesitate to call the Due On Sale Clause,
although most are happy so long as they continue to receive
on-time payments for the life of the loan.
That is why I suggest always to call your lender with a "If I
wanted to" scenario. Don't tell your lender "you did it".
Tell your lender before you sign the paperwork "you would like
to do it".
Test the waters with your lender before you venture into the
deal. Chances are that your lender will agree, so long as the
buyer knows that if the payments come late, that the bank may
exercise its right to Due On Sale.
One More Note
Someone asked what a Demand Clause was and if it is similar to
the Due On Sale Clause. It is similar, but very different. The
Demand Clause allows the lender to demand full payment at any
time for any reason. With the Due On Sale Clause, then full
payment can only be required if the interest in the property
changes hands.
In Conclusion
Tens of thousands of deals are done every year, where the
mortgage holder sets up a Contract For Deed deal with a buyer,
and the lending institution permits the transfer to happen
unimpeded - even though the lending institution has the right to
stop the transaction at any time under the terms of the Due On
Sale Clause.
If you want to sell your home during this housing crisis and
credit crunch, your first best bet is to call your lender and
have a discussion about "If I wanted to sell my house through a
Contract For Deed" scenario.
If your lender says that they would call the note, then you know
that this option is not for you. However, if they indicate that
they would be happy to let you go through with such a deal on
certain terms, then you will know that you have another option
for getting out of that house that you do not want anymore.
Author's Note: This article originally published here:
http://www.libertyhomesellers.com/blog/2009/02/due-on-sale-clause/
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Cory Shrader writes for the Liberty Home Sellers website. Liberty
buys and sell homes in Oklahoma and has regular contacts with
other real estate investors in many U.S. states, who also buy
and sell single-family homes. If you are looking to sell a home,
buy a home, or buy handyman specials, please visit our website
and fill out the appropriate form on our website:
http://www.LibertyHomeSellers.com
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