Due-On-Sale Clause: The Little-Known Provision that Guides Your Home Sale
The “due-on-sale” clause is an important part of many mortgage contracts. While it’s often ignored, it can impact how you buy and sell your next home.
There is a little-known clause in almost all mortgages. It’s a clause that we don’t really think about, one that many don’t even know exists.
Yet this clause determines how you purchase and sell a home.
It’s known as the “due-one-sale” clause, and while you may not know what it is, there’s a good chance it exists on your mortgage.
You should understand why it exists, what loans have it, and how it can impact your home-selling and purchasing experience. In the end, this will make you a more informed and confident homeowner.
How the Due-on-Sale Clause Impacts Your Purchase
The due-on-sale clause is fairly simple, at least in theory. Essentially, it says that once you sell the home, you need to pay off the loan. That’s it.
This clause requires that once you sell a property with an existing mortgage, proceeds from the sale must be used immediately to make complete repayment of the mortgage.
Essentially, repayment of the loan is due when the house is sold.
Mortgages are a type of lien, which means that someone else (in this case, the bank or lender) has legal rights to a portion of your property. If the property that secures the loan is transferred, the lender is automatically informed.
That’s about all there is to it: if you sell the house, you have to pay off the loan. Seems pretty straightforward and obvious. Of course you’d pay off the loan when you sell the property, that’s how everyone does it…right?
Not exactly. When you understand the alternative to due-on-sale loans, you’ll understand why this clause is so important to lenders, and why it makes a big difference on how you can transfer property.
The Alternative: “Assumable” Loans
The alternative to a due-on-sale loan is an assumable loan. Essentially, these loans allow a different person to occupy the property and “assume” (take responsibility for) the mortgage payment. The new owner takes over bill payments, while the previous owner is able to walk away from the property free and clear, and likely with a sizable sum of cash from the new owner.
Assumable loans usually need the lender’s approval, although this is not always the case.
Why Due-On-Sale Clauses?
Due-on-sale clauses exist because the lender does not want an unknown person (the new owner) taking responsibility for the payments. The new owner has not been vetted through the mortgage qualification and approval process, so the lender has no information on them.
They don’t know the new owner’s income, debt load, or credit history, all of which are important factors when approving a loan. (If it’s one thing lender’s don’t like, it’s lack of information.)
Think about it from the lender’s perspective. Imagine you gave your friend Bob a watch under the promise that he would pay you $250 at a later date. You know Bob; and how to contact him, you know he has a good job and he is, as far as you know, good with money. Bob has owed people money in the past and has always repaid, so you feel comfortable giving him the watch.
But the following week, Bob comes to you and says he gave the watch to his friend Carl, and Carl will pay you the $250. You don’t know Carl, you have no idea whether he’s a trustworthy person, you don’t even know if he can afford to pay you $250. Would you be comfortable with this situation?
This is, on a much smaller scale, the essential situation that occurs when a loan is assumed. For obvious reasons, lenders would prefer that the original buyer (Bob) stay responsible for the loan. At the very least, they would prefer to get to know the new buyer (Carl) before approving the transfer.
Another reason that due-on-sale clauses exist is to ensure that borrowers don’t hold on to the loan after selling, taking their home with them to a new property. This would increase the debt burden and increase the chances of default.
Does My Mortgage Have a Due-on-Sale Clause?
Probably. The majority of mortgages, including conventional mortgages, have due-on-sale clauses. To protect themselves, and to guard against future problems, most lenders write a due-on-sale clause into their loan contracts.
The only types of loans that may not have a due-on-sale clause are FHA and VA loans, although these types of mortgages likely have detailed language that severely limits your ability to transfer the property.
How Does this Impact a Seller?
You may not have even realized you had a due-on-sale clause on your mortgage, and it’s likely that you weren’t planning on transferring the mortgage anyhow, so for most people, there really is no impact from the clause.
Basically, all this clause does is stop you from transferring the mortgage payments to another person without the consent of the bank or lending institution. So you can’t simply transfer the property and the mortgage to another person. If that were to happen, the lender would simply call the loan and insist on full repayment. If they don’t receive payment after the property is sold, they could foreclose on the property and seize the home.
How Does it Impact a Buyer?
From the buyer’s perspective, a due-on-sale clause simply means you can’t approach a homeowners and say “instead of going through the loan process, I’ll just take possession of the house and make payments on the same mortgage.”
In theory, this would make the transfer more convenient and less time consuming, but, for reasons we’ve described, the lender simply won’t allow it.
Due-on-sale clauses are in place to protect both the lender and the borrower. They may seem inconsequential, but they have been guiding the home-purchase process for decades.
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