Understanding Due-On-Sale Risk
4 min read
What is a Due-On-Sale Clause?
Most mortgages contain a "due-on-sale" clause that technically allows the lender to call the entire loan balance due if ownership of the property transfers without their consent.
The due on sale clause is a real risk. Many lenders do not act if the loan is paid on time, but it can happen.
Common Confusion
Due-on-sale does NOT mean the bank will foreclose immediately. It means the bank CAN ask for the loan to be paid in full. In practice, many lenders do not exercise this right if payments are current.
How Lenders Often Behave
Here's how lenders often handle these situations:
- The loan remains performing: Banks often prefer receiving interest. A current loan is profitable, and calling it due can end that income stream.
- Calling a loan due can be expensive: It triggers a legal and administrative process that many lenders try to avoid.
- Trust ownership is common: Banks see many properties held in trusts for estate planning purposes every year.
- No public deed transfer: When beneficial interest transfers privately within a trust, there is often no public record triggering bank reviews.
- The seller often remains connected: In many structures, the seller keeps a small beneficial interest, which can reduce any appearance of a "sale."
Garn-St. Germain Act
Federal Law and Transfers
Federal law protects certain types of trust transfers that are common in estate planning. Some creative finance structures try to stay close to these protections, but it does not guarantee a lender will never accelerate the loan.
Hierarchy of Safety in Creative Finance
Not all creative finance structures carry the same risk level. Understanding this hierarchy helps sellers choose the safest approach for sellers situation:
1. Safest: Subject-To Inside a Revocable Trust
Property is transferred to a trust, beneficial interest transferred privately, seller remains as a beneficiary, no public deed transfer shows a sale, and the loan stays current. This mirrors normal estate planning and has the lowest visibility to lenders.
2. Very Safe: Seller Finance (Pure)
When there's no underlying mortgage, there's no due-on-sale clause to worry about at all. The seller IS the lender. This applies to free-and-clear properties.
3. Moderate: Wraps or Hybrid Deals Inside a Trust
The trust adds a layer of protection and privacy. Seller financing wrapped around existing debt, structured through a trust vehicle. Slightly more complex but still well-protected.
4. Least Safe: Subject-To Recorded Directly on Deed
A deed transfer recorded publicly without a trust. This creates a public record that could be flagged by lender reviews. Still commonly done, but carries more visibility to the bank.
What Happens If a Bank Calls the Loan Due?
If a lender exercises the due-on-sale clause, sellers can consider these options:
- Refinance the property: Sellers can try to get a new loan to pay off the old one.
- Sell the property: Pay off the original loan from the sale proceeds.
- Negotiate with the bank: Many lenders will work with sellers if payments are current.
- Allow the original seller to refinance: The seller can potentially get a new loan to pay off the old one.
Risk Tolerance: Many professionals avoid calling the lender because it can create confusion, but sellers should understand the clause and sellers risk tolerance.
Best Practices
- Professional Servicing: Best practice is to use a third-party servicer to manage payments. While some deals are done directly, professional servicing is recommended for transparency and clarity for all parties.
- Keep payments current: Often the best way to keep a lender satisfied is to ensure they receive their payments on time every single month.
- Maintain insurance: Keep proper coverage with all required parties listed. Insurance claims and pasellersts depend on the policy, the loss, and the lender’s process.