Usually, when ownership of property transfers, it is through a traditional purchase and sale. The transaction is voluntary, and title passes through a traditional closing, where the buyer transfers money to the seller. If there is a mortgage, the seller uses part of the money to pay off the loan.
However, not every transfer of property happens this way. In many cases, whether voluntarily or involuntarily, title to property passes in ways that are different than a traditional purchase and sale. Take the following examples:
- Property is transferred from being in a business’ name, to a person’s name, or vice-versa, for tax, asset protection, or other legal reasons
- Property is transferred from being in an individual’s name, into the name of a trust for asset protection or estate planning reasons
- Property is transferred by order of a court, such as in a bankruptcy, or for property that is not exempt, to pay off a creditor
- Property is transferred to a buyer pursuant to a foreclosure
In all of these cases, whoever receives the property may face a problem that he or she did not anticipate — the due on sale clause.
What is Due on Sale?
A due on sale clause is a provision in a mortgage or mortgage note which says that in the event the property is transferred—that is, if ownership of the property changes for any reason—that the lender must be notified. If the lender is not notified, or if it is and it does not consent to the transfer of ownership, the lender can immediately accelerate the balance due on the loan, and foreclose if the entire balance of the loan is not paid off. There are some exceptions to enforcing these clauses, but not many.
Due on sale clauses can create huge problems. Imagine, in one of our examples, someone who transfers property into the name of a trust, in an effort to preserve the property for grandchildren. Even if the mortgage payments on the property continue to be paid, the lender can refuse to accept the payments, and instead, declare the entirety of the loan as being due. Unless someone can come up with the balance of the loan, the property will be lost, for no other reason than it being transferred into the trust without the lender’s consent.
Even if the recipient could pay off the existing, now accelerated loan, the recipient may have to take out a new loan to get those funds. That new loan could have a higher interest rate, and thus, higher payments.
Voluntary and Involuntary Transfers
In some cases, due on sale clauses only apply when the transfer is consensual, such as transferring property into a trust, or a traditional purchase and sale. Other times, the clause will apply even when the transfer is involuntary, such as if a court orders property transferred pursuant to the dissolution of a business. Which one applies will depend on the language in the mortgage.
Understand the documents you are signing at your real estate closing. Contact our real estate attorneys at The Law Office of Agnes Rybar LLC to help you with your purchase, sale or transfer of property.