How to avoid DUE ON SALE when seeking owner financing?

Question

Hey everyone! Quick questions that I am hoping someone with experience in owner financing can answer. I am seeking owner financing on a single-family deal near me. The seller is up for it, but the mortgage does have a due on sale clause that would stop me from being able to go through with this financing method. What are some ways around due on sale?

Joe Splitrock · Answer

That is what Pace said, but he was incorrect. There is not insurance. He was trying to promote his own company that has assurance, which appears to be more like a warranty. The website was sketchy at best, so I would avoid this service.

Probably better to just do as @Steve Vaughan suggests and avoid the "assurance". Most the time these things don't get caught or flagged as long as you are paying the mortgage. As a back up plan, you can refinance the property if the loan gets called. That is really all the "assurance" does is helps you find financing. There are tons of non traditional lenders out there, so you would have options in a pinch. Still low likelihood the loan is called. Banks don't make money calling loans and foreclosing, so they only do those things if they are not getting paid.

Michael Temple · Answer

@Hoa Nguyen you should know there is no way "around" a due on sale clause. It is there and it can be triggered. Instead it is helpful to understand the risks and some mitigation strategies. First a bit of history, at one time most banks held their own mortgages. The due on sale clause was implemented because these banks wanted a tool to force buyers to refinance at what was then increasing interest rates and hence get more income. Today the mortgage market doesn't really work that way any longer. Banks rarely hold their mortgages any longer. Most are bundled with millions of dollars of other mortgages, securitized, chopped up, and sold off as investments in the secondary market to retirement plans, hedge funds, etc.

As my mortgage guy, who has been in the business 38 years, said today when you make your payment to "the bank" you are really just paying someone that is servicing the loan, not the originator or holder of the loan. So pulling a performing mortgage out of one of these bundles and calling it due because someone took it over without paying it off is difficult. Most servicers, when they find out, don't even have clear steps as to what they are supposed to do so they end up doing nothing unless it goes into default. A default is clear and understandable to them. They have specific steps and guidelines that go into effect when a loan is in default, but a due on sale clause is not as clear.

Now having said that understand that it COULD still occur. It might be unlikely, but not impossible. The one area people get tripped up and cause someone to take action is when the insurance gets messed up. The really experienced investors that have done these a lot and whose opinion I trust say to get a new policy and make sure the original borrower is in that policy as an additional insured. Investors seem to mess this step up and the banks that service these things find the original borrower is no longer insured and they start digging, which is when stuff unravels.

Finally, you need to be in a position to take out the original lender if it does get called. As others have said, the chances might be small, but they are still there. Being able to refinance the property or bring in a money partner to pay it off is ideal. I would say avoid using the subject to strategy unless you have a clear way of paying it off in the event it does happen.

In my case, I maintain a HELOC that I can use to pay off a property in a pinch. That would give me some time to then replace that loan with something more permanent. I could probably also just refinance the loan if needed. Finally, I am always cultivating financial friends/lenders that might be able to help me out in a jam.

Steve Vaughan · Answer

When doing a wrap, it's important that the 1st mortgage is more than 1 year old and there isn't a HELOC on the house.    How old is the 1st mortgage?    Is there a LOC?

Basically you are hoping the sale isn't discovered.  You need to make the payments and be prepared to satisfy if it is called. I make payments electronically through my mgt corp. You may want a holding LLC or similar.  Easy to establish outside of CA.

The primary way the transfer is discovered is the change of hazard insurance notification.   Leave the primary borrower on the insurance and just add yourself as additionally insured.

Research wraps or wrap-around mortgages on here.  They're not common these days but we used to discuss them quite a bit.

Tom Gimer · Answer

@Hoa Nguyen You should be able to find an investor-friendly title company who will not only close your subject-to transaction, but also provide owners title insurance. Of course the mortgage(s) remaining open will be special exceptions on the policy and you'll have to agree to release and hold harmless the title company should things go sideways with the lender(s). Good luck.

Joe S. · Answer

There are inherent risk for Sub2 deals.  I have done Sub2 and never had one called ,but we do not play games concerning making payments and we get the insurance right.

I’m not sure why this method  is promoted so much to people that have no credit, no job, and no stability. I’m not saying that’s you, but I would not promote this method to newbies.

Steve Vaughan · Answer

Of course it's 'better' to utilize a title co, but they won't touch this.  They are in the business of writing fee simple title insurance policies.  No subject-to's. After a prelimimary search on my own, I pay for a full O&E (owner and encumbrance) report.  They (First American is the only one I have found in my area that does it) e-mail me all I need to know for $150. Then I draft a special warranty deed or similar and record it if no surprises. Your state may convey with a different type of deed but I would try for better than a Quitclaim.  Look up recorded docs in the county of the house.  See the types of deeds and how they're written.

John Clark · Answer

A transfer of title (or of beneficial interest in a land trust) triggers a due on sale clause when money changes hands (meaning it's not an inheritance situation). The lender may choose not to enforce the clause, but that is solely up to the lender. No "subtle" machinations can get around that.

Peter Walther · Answer

While there is a common theory that banks began including a due on sale because they're inherently greedy, which I don't disagree with, I believe lenders were also concerned that their chances of being repaid might be impaired if the new purchaser was less credit worthy, then the Borrower.  From a contract point of view, if you and I make a contract, I probably will include a provision the contract cannot be assigned without my agreement, and vice versa, because I may not want to do business with anyone but you.

Andrew Postell · Answer

@Hoa Nguyen you have some really good comments above.  REALLY good comments.  There's risk to everything and this is a strategy that does have some risk...but maybe not as much as some people describe...and maybe more risk than others describe.  The underlying note is really important to know the language and even know the lender too.  Some lenders won't allow you to make an automatic payment on a loan unless you are listed....so we have to make a non-auto drafted payment each month.  So even the lenders might have a little to say here.  Doesn't mean you shouldn't do it but just be aware that there are some little nuances to "subject to" deals.  I did write an entire post on the due on sale clause that you can read HERE.  It's basically the summation of what everyone has mentioned here but still might be a good read all the same.  Good luck!

How to avoid DUE ON SALE when seeking owner financing?

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