Every week, we work with buyers and sellers involved in Austin Owner Finance transactions. Every once in a while we will run in to sellers that are terrified of triggering the acceleration clause (referred to as the Due on Sale clause) found in the underlying mortgage contract. In every case we have worked with thus far (which are hundreds) this fear is generally uncalled for and it originates more from ignorance about the potential use and implementation of this clause rather than the reality itself.
What is the Due on Sale Clause?
To begin with, the Due on Sale clause is, and has for decades been, a common provision in a mortgage or a deed of trust which allows the lender or mortgagee to demand immediate payment in full of the remaining balance of the loan if the mortgage holder transfers the property. Simply put, a due-on-sale clause is a standard provision in a mortgage or deed of trust that states that the lender has the right to demand that the entire balance of the loan, at the lender’s sole discretion, may be called due upon any transfer of the property used to secure the promissory note.
Although the lender has the contractual right, it isn’t a law and they do not have a hard and fast obligation to call the note due in the event of a sale. Again, this is a contractual right of the lender, not a legal requirement. This means that if a transfer takes place, the lender may (or may not), at its sole discretion, decide to “call the loan due.”
Notice that in the paragraph above it was stated that the lender the due on sale clause is triggered by a transfer of the property – nothing at all has been said regarding the word sale. Technically, a transfer is any transaction which transfers any ownership or title to the property, whether it is equitable or legal title. This can take numerous forms and can even consist of a common lease-option (which is an executory contract whereby a transfer of equitable title occurs) even though the lessee hasn’t even exercised his or her option to actually purchase the property yet.
Is Violating the Due on Sale Clause Illegal?
The common, and often mistaken belief, is that transferring any property already secured by a mortgage with a Due on Sale clause is somehow illegal. This is untrue due to the fact that triggering this clause is a matter of civil, not criminal, liability. By definition, in order for something to actually be considered “illegal”, it must first be in violation of a criminal law, code, or statute and there is currently no state or federal law which makes it a crime to violate a Due on Sale clause. In other words – these transactions are legal.
So, when considering a Owner Financed home purchase or sale, such as those utilizing a wraparound mortgage, the question to ask is whether or not both parties are willing to enter into a transaction subject to a mortgage containing a Due on Sale clause and risk getting caught. This is often a risk versus reward situation that normally makes sense to do. More often than not, the seller has been denied Austin short-sale options, he or she is unable to sale the property to a buyer that can obtain traditional financing, and the mortgage is in arrears and facing possible foreclosure if the sale does not occur soon so that payments are caught up and the loan brought current. So what’s the risk for the seller? Usually nothing. More often than not he or she is already facing foreclosure and the wraparound mortgage is the only means to prevent that from happening. If the loan does get called due, then the situation isn’t really any worse for the seller than it was before the sale. On the flip side, the buyer may have had past credit-related issues, he or she may not have enough money for a 10% or 20% down payment, or the buyer may not otherwise qualify for a traditional mortgage loan due to employment, income, or other issues. Without this Owner Financing option, the possibility of home-ownership for the new buyer is slim to none. The gamble is usually pretty safe for both parties.
With regards to wrap mortgages, the due-on-sale clause is an obvious issue of concern for any property owner that wishes to transfer (sell) the property and have the new buyer take over the existing loan rather than paying it off as part of the sale as in a normal transaction involving third-party financing. The downside is that, as already stated, if the lender finds out about the transfer and then decides to call the loan due and the balance is not paid off, the lender could of course choose to foreclose on the property – which means that the seller now has a foreclosure on his or her record and the new buyer is also subsequently evicted in the process, which also means the entire loss of all down payments and other monies paid. This could, of course, lead to other frivolous litigation between the parties. However, the likelihood of this actually happening is pretty low and it really depends on how the real estate market is doing at the time. The reality is that as long as the buyer continues to make the loan payments when they are due, it is unlikely that the lender will actually call the loan due and payable. Given the extremely low interest rates that are expected to exist for the next few years and the current backlog of non-performing assets that banks already have on their books, calling a current and performing loan due isn’t very likely at all.