HOW TO: Avoid the “DUE ON SALE” Clause

Question

In continuing with my “HOW TO” series I thought I would post on a topic that has reared its head again lately – the notorious “due on sale” clause (key terrifying music). Every few years this will get talked about and so I thought it would be a good idea for us to cover this right here and now.

In this post we’ll cover what the “due on sale” clause is, I’ll even show you the actual verbiage from the clause itself, and then how you can avoid it. Let’s get started.

What is the “Due on Sale” Clause?

The “due on sale” clause, as its commonly referred to, is 2 paragraphs that are usually located in Fannie Mae and Freddie Mac “notes” (which is the specific form/instrument that outlines the terms of your mortgage). These paragraphs give the lender specific rights to call the loan due in full if the title ever changes. For example, if you ever sold the property they could demand the entire balance of the loan. While the two paragraphs in question don’t actually use the terms “due” or “sale” it’s been given that name through the years to provide an easy way to explain the verbiage.

Normally, if there is a loan attached to the property that loan is paid off when you sell it. The cause for concern though is what if I don’t WANT to pay off that mortgage (like in an owner financed scenario) or if I just change the title to my LLC after closing - would the lender call my note due? And the short answer is no…AS LONG AS YOU ARE PAYING ON TIME. So let’s examine this a little bit more.

This is the first paragraph of the “due on sale” clause. As mentioned above you will find this verbiage in your “note” and it’s only 2 sentences.

2 Really Important Legal Phrases

The first really important legal phrase to understand in this clause is “may”. The lender MAY require immediate payment. This is really important to understand because the lender isn’t FORCED to require this. It’s their choice. And if we leave it up to them, they won’t…as long as we pay that mortgage. The lender MAY require immediate payment. Let’s examine why a lender wouldn’t do this a bit deeper:

Payment in Full – lenders make TONS of money on mortgages. Look at your “closing disclosure” the next time you receive one. You’ll see how much interest they make on page 5. It’s TONS of money. TONS! For a lender to request a loan in full – they stop making money on it. No lender is going to do this. Just keep paying that loan on time and you’ll be ok.
Performing vs. Non-Performing – For a lender to call a note due in full they are basically re-classifying a performing asset on their own balance sheet to a NON-performing asset. This can affects a lender’s credit rating. Seriously. This can affect their own interest rates if they went to borrower money (and every lender does). No lender is going to risk their own borrowing power on an already great performing asset. It wouldn’t make sense. Just pay it on time.
Cost – When a lender calls a note due, that is essentially them foreclosing on a property. This means they now need legal representation to do so in most states. Just another cost that a lender has to consider on a PERFORMING asset. Now they are spending money instead of making it? They ain’t doing this either. Pay that mortgage.
Public Relation Nightmare – could you imagine if a lender were to start foreclosing on people who are paying their mortgages on time? This would be the dumbest PR move in this history of banking. Banking already has a pretty negative image in the US…maybe neutral at best…there’s no way that a bank is going to risk its image on a loan that already makes them TONS of money. It would backfire completely. They aren’t calling the note due. Have I said to pay the mortgage on time enough yet?

And you might be able to think of some other reasons too. But it's just that simple. Keep your mortgage servicer happy (by paying on time) and you can certainly transfer the deed to your LLC or Land Trust or whatever other strategy you need to do. Keep in mind that this post is NOT addressing other things you should consider when wrapping a note or transferring title…but just the act of transferring title itself.

But let’s examine one other scenario – WHAT IF MY LENDER DOES LOSE ITS MIND AND CALLS THE NOTE DUE?

That’s what the 2nd paragraph is for:

The 2nd paragraph here highlights the OTHER really important legal term – “not less than 30 days”. That means they must provide you, at minimum, 30 days to change the title back to the original name on the loan. So even if your lender does lose it’s mind – they still have to give you time to find a solution. And in most states changing the title back is 1 piece of paper. It’s really easy. Now if you did wrap the loan, changing it back would not be possible. So just know that going into it that if something beyond reasoning, that has never happened in the history of happening, were to happen…you would need a solution to it if you were wrapping Fannie/Freddie money. And yes, there are lenders who WOULD refinance a note in this type of a scenario where you didn’t own the property anymore. The terms wouldn’t be as good but it is possible. Again, this is very unlikely to ever occur but you can see that there is time to find a solution if it were to happen.

And that’s it. I hope all of this makes sense. If you are interest to read any other of the “How To” posts that I write check out the others listed below. Thanks for reading!

How to: buy a property in cash - HERE

How to: find investor friendly lenders - HERE

How to: Avoid Seasoning - HERE

Russell Brazil · Answer

Once the lender receives the new insurance policy to properly insure the new owner, that is what triggers thr due on sale clause. The reason lenders do not typically call the note due, is because the insurance is never updated to properly reflect the new owner of the property. So 90% of people who are moving the property into an entity are for all intents and purposes, uninsured.

Kelvin J. · Answer

Andrew thanks for typing your how-to series up and sharing. There's so much important info here and you present it in an easy to digest way.

Andrew Postell · Answer

Account Closed thanks for this example! This is very interesting to hear about. Thanks for sharing.

Account Closed · Answer

In my Humble Opinion of 30 years of doing Subject To, one should Never Never Over leverage Subject ToNever do Subject To without adequate liquidityNever do Subject To without adequate reservesNever do Subject To without trainingNever do Subject To and try to take out a secondNever do Subject To without proper disclosuresNever do Subject To with a foreclosureNever do Subject To with a “protected class” There are other “never do’s” but they seem to be ignored in the general discussion of Subto and people will find out why they should not ignore them, if they are even aware. Get “properly” trained on what is safe & legal about Subject To, before jumping in.

Account Closed · Answer

An interesting twist to your great information, is an actual legal case I participated in. The borrower sold his property Subject To. The buyer paid as agreed on the loan. After a couple of years, the borrower for some reason lost his mind (figuratively) and contacted the lender to let them know he had sold the property. Ocwen, the lender, lost their mind and called the loan, a performing note, due. The buyer sued. The buyer stated in court documents that all payments had been paid on time and presented proof of such payments. Ocwen admitted all payments had been made on time. The borrower also told the court that the "Due on Sale Clause" says the lender "May" call the note due but isn't compelled to. The lender filed a lis pendens tying up the title. So, a couple of months after the suit was started the buyer said "heck with it" (or "bananas" if you don't care for cursing) and stopped paying the mortgage. @Andrew Postell can see right away where this is going. As long as the case was active the court wouldn't let Ocwen foreclose and the lis pendens prevented the now owner from selling since he couldn't get clear title. After Two Years (2 years) the case was settled giving the buyer a hefty sum of money from Ocwen. No, he didn't keep the property, it was at a time when prices where stagnant, however, because he wasnt making payments, the arrears had eaten up all the equity and then a bunch more. Since teh loan wasn't in the buyer's name, he had no impact on his credit. The original seller whined about not getting any money out of the settlement. Ocwen had two years of legal fees and a non-performing note and had to pay a settlement amount with an NDA. The buyer understood how the system works and used it wisely. ;-O

Melanie P. · Answer

The issue is a lack of control over anything going on with the mortgage and anything associated with it. The seller will be long gone. It's not your policy so you can't make changes to the prior owner's policy for a property they no longer technically own. The seller lacks an insurable interest other than their obligation to pay the loan. Subject To deals are RARE, but being familiar with the concept can allow you to get a deal done quickly, with a real plan to get the seller's note paid as soon as is practical, but immediately if it becomes necessary. Subject To should not be used, IMHO, by someone who is simply financially unqualified to finance the property.

Andrew Postell · Answer

@Sandy Sawyer ok, assuming your mortgage is not assumable, this would mean you would do owner financing with a wrap. Sometimes referred to shortly as "owner wraps". Meaning, you create a note that "wraps" over the existing mortgage. So, yes, you ABSOLUTELY need to structure these types of transactions correctly. Not just for this reason but for other reasons too. Just search for that term, get plugged into local real estate groups in your area, and seek out training or an instructor on that subject. That type of training comes around often.

Russell Brazil · Answer

You refinance the property to a commercial loan in the name of the LLC, and you get a commercial insurance policy covering the LLC.

Andrew Postell · Answer

@Russell Brazil love seeing you have more "votes" than you do "posts". Awesome work sir. And your post here is right on.

Ruben Feletoa · Answer

Thanks for this. Awesome information ℹ️