The Don'ts Of Due On Sale Clause

The Don'ts Of Due On Sale Clause by Bill Roberts

The DUE ON SALE CLAUSE has been around a long time. What it basically means is that if you sell your property the bank will call the loan due.

Naturally, on occasion we would like to be able to buy or sell real estate and leave the financing in place.

There are a lot of strategies bandied about that purport to get around the Due On Sale Clause:

• The Land Contract
• The All Inclusive Trust Deed (aka the Wrap Around Mortgage)
• Lease Option
• The Land Trust

Now each of these methods will allow you to "hide" the transfer from the lender, but it should be understood that the Due On Sale Clause is triggered nonetheless. And don't fall into the trap that you haven't taken title so the trigger wasn't pulled. Not so! A lease for more than three years OR an option to purchase meets the necessary threshold to trigger the Due On Sale Clause.

Just because the lender doesn't know doesn't mean they don't have the right to call the loan.

As a matter of fact, if you hide the transaction from the lender which triggers the Due On Sale Clause you may be guilty of loan fraud.

If you want to purchase a property subject to the existing financing, go ahead. The worst thing that could happen is for the lender to call the loan due. It doesn't mean that they will, only that they could. If they do and you can't pay them off or refinance you will probably lose the property.

Now it wasn't always this way.

Lenders have always wanted the right to call a loan due if there was an alienation of the title to the property. They have interpreted this to include junior liens, leases, additional owners, taxes, and change of use in addition to out-right sale.

But Fred Crane represented Cynthia Wellenkamp against Bank of America when they called her loan due for alienation of title. She had purchased the property subject to the existing Bank of America loan.

Fred Crane won the case. It went all the way to the California Supreme Court in 1978. They said:

...we hold that a due-on-sale clause contained in a note or deed of trust cannot be enforced upon the occurrence of an outright sale unless the lender can demonstrate that enforcement is reasonably necessary to protect against impairment to its security or risk of default. We therefore disapprove...(citations omitted) and overrule to the extent inconsistent the case of Coast Bank vs. Minderhout, supra.

This was based on the principle that any restraint on the transferability of land is repugnant to the concept of FEE SIMPLE ABSOLUTE.

This was first enacted by Parliament in 1290 AD as the Statute Quia Emptores.

After Wellenkamp, all Due On Sale Clauses were void in the State of California.

It was great. If the buyer didn't have credit, or couldn't qualify according to the lender's underwriting standards, or the interest rate for a new loan was too high, no matter. We could transfer the property to the buyer subject to the existing financing. Hallelujah.

This went on for several years. As you can imagine, the banks hated it. They were losing money. Even though they lent you the money for thirty years, they didn't expect you to keep it for thirty years. They wanted it back so they could lend it again and collect more fees and maybe higher interest. Talk about bad sports.

Congress to the Rescue

Well, anyway, they (the banks) had friends in Congress. So in 1982 Congress passed The Depository Institutions Act of 1982 (commonly known as the Garn- St. Germaine Act) which re-instated the Due On Sale Clauses in all mortgages made by any depository institution, whether state chartered or federally chartered.

The Due On Sale Clause

This is what the original FNMA/FHLMC due-on-sale clause looked like:

"If all or any part of the Property or an interest therein is sold or transferred by Borrower without Lender's prior written consent, excluding (a) the creation of a lien or encumbrance subordinate to this Mortgage, (b) the creation of a purchase money security interest for household appliances, (c) a transfer by devise, descent or by operation of law upon the death of a joint tenant or (d) the grant of any leasehold interest of three years or less not containing an option to purchase, Lender may at Lender's option declare all the sums secured by this Mortgage to be immediately due and payable."

So now you know (a) all mortgages contain a Due On Sale Clause, (b) you trigger it at your peril, and (c) Congress is not your friend (unless you are a bank or are as rich as Croesus).

Real Estate Broker's Duty

Both the seller and the real estate broker have a duty to disclose to a buyer any material fact that would affect the buyer's decision to buy, or the price or terms of purchase. The broker specifically has the duty to inform the buyer of the due-on-sale clause in every real estate transaction. (Eby v. Reb Realty, Inc., 9th Circuit, 1974, 495 F 2d 646) Thus the advice of the broker to 'hide' the transfer by use of an installment contract or wraparound deed of trust exposes the broker to liability for damages suffered by the buyer.

We have probably not heard the final word on this controversy.

If you want to discuss this or any other real estate matter call Bill Roberts (619) 244-4610.