Due-On-Sale Exceptions

What are Due on Sale Exceptions?

A “due-on-sale clause” is defined by the United States code as a contract provision which authorizes a lender, at its option, to declare due and payable sums secured by the lender’s security instrument if all or any part of the property, or an interest therein, is sold or transferred without the lender’s prior written consent. 12 U.S. Code §1701j-3. The lender has the option to make the loan payable if the real estate is sold or transferred. These provisions are common for any standard mortgage agreement.

This scenario is unlikely to happen in a bona fide sale between two parties represented by counsel. Indeed, the buyer’s attorney would conduct a title examination before the transaction occurred. Then, the unreleased mortgage at the registry of deeds would appear as a cloud on title. However, when individuals are gifting or making transfers to a trust, they could run into issues due to their mortgage.

What are Exempt Transfers?

The code provides for transfers which are exempt from due-on-sale provisions. It would be illegal for a lender to trigger a due on sale clause in the following situations:

1. The creation of a lien or other encumbrance subordinate to the lender’s security instrument which does not relate to a transfer of rights of occupancy in the property;
2. The creation of a purchase money security interest for household appliances;
3. A transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety;
4. The granting of a leasehold interest of three years or less not containing an option to purchase;
5. A transfer to a relative resulting from the death of a borrower;
6. A transfer where the spouse or children of the borrower become an owner of the property;
7. A transfer resulting from decree of a dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement, by which the spouse of the borrower becomes an owner of the property;
8. A transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property; or
9. Any other transfer or disposition described in regulations prescribed by the Federal Home Loan Bank Board.

Due on Sale Clause and Estate Planning

The exception to the due on sale clause which typically occurs in probate matters is number 5. This exception covers the scenario where the death of the borrower results in the property being passed to a family member. However, it is important to note that if the devisee is not a relative as defined by statute, then they will not qualify for the exception.

Numbers 6 and 8 are the most frequently used exceptions in estate planning. Number 8 covers transfers to inter vivos trusts. However, the borrower must remain the beneficiary of the trust as well as maintain their right of occupancy. This can be problematic when transferring to an irrevocable inter vivos trust under which a child becomes the beneficiary. Which is why number 6 becomes so important, as number 6 allows for a transfer from the borrower to either their spouse or one of their children. This ensures that estate planning can be accomplished even when a mortgage is on the property.

Problems with Due-on-Sale Clause

The scenario where estate planners run into problems with the due-on-sale clause is when the borrower wishes to include non-relatives as a part of their estate planning. This is particularly common among partners who have never legally married and thus do not enjoy the legal benefits. It can also occur when the borrower has no children, and wishes to leave the property to individuals with which they share no blood relation. In these cases, it is important to be very careful with the interplay between estate planning and your real estate, as a mistaken trigger of a due-on-sale clause could be catastrophic for a borrower.