Due-on-Sale Clause: Definition, How It Works, Example, Exceptions

What is a "Due-on-Sale Clause"?

A Due-on-Sale Clause, also known as an acceleration clause, is a provision commonly found in mortgage agreements and loan contracts. This clause gives the lender the right to demand immediate repayment of the outstanding loan balance if the borrower transfers or sells the property securing the loan. The purpose of the Due-on-Sale Clause is to protect the lender's interests and prevent unauthorized transfers of the property.

Key Features of a Due-on-Sale Clause:

Transfer of Ownership: The Due-on-Sale Clause is triggered when there is a change in the ownership of the property that serves as collateral for the loan. This change can occur through a sale, transfer, or conveyance of the property.
Lender's Consent: Typically, the borrower is required to obtain the lender's consent before transferring ownership. If the borrower wishes to sell the property, the lender has the right to approve or disapprove of the sale. Failure to obtain consent may trigger the Due-on-Sale Clause.
Acceleration of Loan: If the borrower transfers the property without obtaining the necessary consent, the lender can exercise its right to accelerate the loan. Acceleration means that the entire outstanding balance becomes due and payable immediately.
Protection of Lender's Interests: The primary purpose of the Due-on-Sale Clause is to protect the lender's interests by preventing unauthorized transfers of the property. It allows the lender to assess the creditworthiness of the new property owner and adjust the terms of the loan if necessary.

How It Works:

Notification to Lender: If the borrower intends to sell or transfer the property, they typically need to notify the lender and seek approval. The lender may request information about the potential buyer's financial stability before granting consent.
Lender's Decision: The lender has the discretion to approve or deny the proposed transfer. If the borrower meets the lender's criteria and the sale is deemed acceptable, the lender may provide consent.
Due-on-Sale Clause Activation: If the borrower transfers the property without obtaining the lender's consent, the Due-on-Sale Clause is activated. The lender can then choose to accelerate the loan, demanding full repayment of the outstanding balance.
New Financing or Refinancing: In some cases, if the new property owner wishes to keep the existing loan, they may need to either assume the mortgage (if allowed by the lender) or refinance the loan in their name.

Example of a Due-on-Sale Clause:

"If all or any part of the Property or any interest in it is sold or transferred by Borrower without Lender's prior written consent, excluding (a) the creation of a lien or encumbrance subordinate to the security instrument, (b) the creation of a purchase money security interest for household appliances, and (c) a transfer by devise, descent, or operation of law upon the death of a joint tenant or upon the death of a spouse resulting from a decree of dissolution of marriage, or (d) 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, then Lender may, at Lender's option, declare all the sums secured by this Security Instrument to be immediately due and payable."

Exceptions and Limitations:

Transfer to a Family Member: Some Due-on-Sale Clauses have exceptions for transfers to certain family members, such as a spouse, child, or parent. In such cases, the lender may allow the transfer without triggering the clause.
Transfer into a Living Trust: Due-on-Sale Clauses may allow the transfer of the property into a revocable living trust where the borrower remains the beneficiary and maintains control over the trust.
Transfers by Operation of Law: Transfers due to divorce, legal separation, or the death of a joint tenant may be exempt from the Due-on-Sale Clause, as they occur by operation of law.
Non-Recourse States: In some states, if the loan is non-recourse, the lender's remedy upon a default may be limited to foreclosure on the property rather than pursuing a deficiency judgment. This may affect the practical impact of the Due-on-Sale Clause.

Legal Considerations:

State Law Variations: Due-on-Sale Clauses are subject to state laws, and their enforceability can vary. Some states have specific regulations governing the use and enforcement of these clauses.
Loan Assumption: In certain cases, a Due-on-Sale Clause may allow for the assumption of the existing loan by the new property owner if the lender approves.
Review of Contract Terms: Borrowers should carefully review the terms of their mortgage agreements, including any Due-on-Sale Clauses, to understand the specific conditions and limitations imposed by the lender.
Legal Advice: Given the potential legal and financial implications, individuals involved in property transfers or sales should seek legal advice to ensure compliance with the terms of their mortgage agreements and to understand the applicable laws in their jurisdiction.

Due-on-Sale Clauses play a crucial role in protecting the interests of lenders and are an integral part of mortgage agreements.