Understanding the Due-on-Sale Clause in Loans – What It Means for Homeowners

When obtaining a mortgage loan to finance a home purchase, borrowers sign lengthy and complex loan contracts with various clauses and provisions. One such clause that often raises questions is the due-on-sale clause.

This article explains what a due-on-sale clause is, how it works, its purpose, and the implications for homeowners when selling or transferring property with an active loan.

What is a Due-on-Sale Clause?

A due-on-sale clause is a provision commonly found in mortgage contracts and deeds of trust It grants the lender the right to demand full repayment of the entire outstanding loan amount when the property securing the loan is sold or transferred,

This clause prevents the homeowner from selling the property to a new buyer without first settling the loan with the existing lender The buyer cannot simply take over and assume the seller’s mortgage

When the due-on-sale clause is triggered, the lender calls the loan “due and payable.” This requires immediate repayment, often when the home is sold or title is transferred. This can happen upon the death of the borrower when property transfers to heirs.

Why Do Lenders Include This Clause?

There are a few key reasons why lenders incorporate due-on-sale clauses:

• To mitigate risk – When an existing borrower sells to a new owner, the lender loses control over who now occupies the property used as collateral. The clause allows them to reassess risk with new borrowers.

• To adjust loan terms – If interest rates have risen, the lender can require the new buyer to borrow at updated higher rates rather than allowing assumption of lower-rate loans.

• To limit transferability – The lender intends the loan to be between specific parties only. The clause prevents unapproved transfers.

• To ensure promises are kept – Any agreements made by the seller regarding insurance, maintenance, fees, etc. cannot be enforced with a new owner.

• To collect fees – The lender may charge an assumption fee if the property does transfer to a new buyer with the loan.

Essentially, these clauses provide lenders with control over their collateral, ability to re-evaluate risk, and opportunity to adjust loan terms to current market conditions.

How Does a Due-on-Sale Clause Work?

When a property owner with an existing mortgage loan attempts to sell their home, the due-on-sale clause can play out a few ways:

Pay off loan – The seller repays the entire loan amount owed to the lender from sale proceeds, releasing the lien so the property transfers free and clear.

Obtain lender approval – The buyer can assume the seller’s loan or apply for new financing with the same lender if they meet eligibility criteria.

Trigger acceleration – If the loan cannot be assumed, the lender requires full payoff upon sale due to the clause.

Foreclosure risk – If the seller cannot repay the loan, the property could be foreclosed upon by the lender.

Renegotiate terms – The buyer and lender may negotiate higher interest rates orfees so the loan can transfer while adjusting terms.

The ideal options are to pay off the loan or obtain lender permission to transfer ownership without triggering acceleration.

Are All Mortgages Subject to Due-on-Sale Clauses?

Most conventional loans and mortgages feature due-on-sale clauses of some kind. Specific conditions may include:

• All transfers – The lender can accelerate with any title transfer including sales, gifts, inheritance, etc.

• Unauthorized transfers – Only certain sales or transfers allow assumption instead of automatic acceleration.

• Partial transfers – Selling percentage of ownership stake could trigger the clause.

• Transfers into trusts – Moving property into a living trust may be barred or limited.

• Interest rate thresholds – The loan can only transfer if rates are under a certain threshold vs. the original loan.

• Time limits – Loans may only be assumable for a certain period before acceleration is triggered.

Review your mortgage paperwork or contact your lender to understand the specific terms that apply to assumption vs. mandatory payoff.

Are There Loans Without Due-on-Sale Clauses?

Most standard conventional mortgages and lenders include due-on-sale clauses. However, the following loans may provide more flexibility:

• Seller financing – The seller carries back financing that allows the buyer to assume the mortgage.

• Portfolio loans – Loans held on the lender’s balance sheet without securitization into the secondary market.

• VA loans – Eligible VA loans can be assumed but may require lender notification.

• USDA loans – Permitted on eligible USDA rural development loans.

• FHA loans – Qualified FHA buyers can assume low fixed-rate loans.

• HELOCs – Home equity lines of credit may be assumable if recorded properly.

• Commercial loans – Retail, industrial, office space loans with flexible terms for buyers.

• Leases – Ground leases allowing a tenant to secure financing separately.

Overall, most mortgages today include due-on-sale clauses with limited flexibility for transfers or assumptions.

What Are the Impacts on Homeowners?

Due-on-sale clauses can create challenges for sellers including:

• Requirement to fully repay loan at closing since buyer cannot assume mortgage.

• Potential need to take out personal loan to settle with lender if sale proceeds are inadequate to clear loan.

• Lower offer prices on home because buyers cannot inherit low interest rate on existing loan.

• Difficulty finding buyers unable to obtain financing without seller financing.

• Burdensome qualification requirements to prove new buyer’s creditworthiness in order to allow assumption.

• Limitations on transferring into trusts or through inheritance or gifting strategies.

• Possibility of foreclosure if loan cannot be repaid and home cannot be sold.

Homeowners should be aware of their loan terms to avoid surprises or shortfalls at the time of sale. Reviewing the clause in detail is key.

Can a Homeowner Negotiate the Clause?

Ideally, the due-on-sale clause should be negotiated when originating the mortgage loan, if possible. However, if selling the home, the seller can discuss options with the lender such as:

• Requesting exemption from acceleration based on specific hardship reasons.

• Asking lender to waive fees or provide a rate discount to buyer to facilitate assumption.

• Offering partial loan repayment if lacking enough sale proceeds to satisfy fully.

• Filing for a temporary restraining order to delay foreclosure and finalize a sale.

• Selling via installment land contract with payments over time rather than lump-sum payout.

• Informing buyers upfront about requirement to obtain their own financing.

While the lender is not obligated to modify terms, it does not hurt to negotiate politely. Any creative solution that protects their interests while accommodating the sale has potential.

Key Takeaways

The due-on-sale clause gives lenders considerable control over what happens when a borrower transfers mortgaged property to a new owner. This provision allows them to mitigate risk, adjust terms, and protect their interests. Homeowners benefit from being aware of this clause before buying and especially before attempting to sell or transfer ownership. While restrictive, understanding how the clause works provides clarity for moving forward with appropriate financing strategies when transacting real estate with a loan in place.