Way back around 1980 when interest rates were climbing, mortgage companies wanted to make sure they got in on the action instead of being tied into 30-year mortgages at the lower, previous rates. Wouldn’t it be nicer for them if they could ensure that if any property was transferred, any remaining debt would have to be refinanced at the current higher rate?
Thus was born the due-on-sale clause. The Garn-St. Germain Act of 1982 made the enforceability of the due on sale clause a federal issue. Lenders do not have to include a due-on-sale clause, but nearly all do. The lender has the right, but not the obligation, to call their note due when the property sells or transfers from one owner to another.
Historically, the due-on-sale clause has rarely been called. This is because interest rates dropped lower and lower in the decades since the law was passed. Why ask a new owner to refinance if the new rate will be even less favorable to the lender?
Now there is no place left for interest rates to go except up. They have held pretty steady for the last few years, but are poised to grow. And when they do, you can bet that due-on-sale clauses will come in mighty handy for the lenders.
Due On Sale Clause Exceptions
Luckily, the Garn-St. Germain Act provides exceptions to the clause. Its list of exceptions is as follows:
- Creating a lien or other encumbrance not relating to a transfer of rights of occupancy
- Creating a purchase money security interest for household appliances
- Transfer on death of joint tenant or tenant with right of survivorship
- Granting a leasehold interest of three years or less without an option to purchase
- Transfer to a relative resulting from the death of the borrower
- Transfer where the spouse or children become an owner
- Transfer resulting from a dissolution of marriage, legal separation, or incidental property settlement agreement, by which the spouse of the borrower becomes an owner
- Transfer into an inter vivos trust (living revocable trust) in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy
- Any other transfer or disposition described in regulations prescribed by the Federal Home Loan Bank Board.¹
So the transfer of property due to common estate changes such as death or divorce or even through getting money out for remodeling or to put in a short-term lease will not trigger the due-on-sale clause. Neither will putting it into a living revocable trust, as long as that trust remains fully revocable.
Note that land trust schemes run afoul of this law. There is no exception for the transfer of a mortgage into an LLC. Hundreds of thousands of properties have been put into land trusts where an LLC is the beneficiary. According to exception 8 above, to avoid the due-on-sale clause, the trust must remain revocable. If and when the land trust owner sells any shares of the land trust to others, the due on sale clause is triggered and the lender has the right to call the loan.
Statue Of Limitation For Triggering
There is no statute of limitation for enforcement of a due-on-sale clause after the transfer of a mortgaged property into an LLC, so a bank can wait until interest rates have gone up several years down the road and then enforce the clause. Most transfers of your personal residence are covered in the exceptions, and you lose a lot of tax benefits as well as homestead exemption protection if your personal residence is transferred into an LLC, so don’t put your home into an LLC regardless. Putting it into your living revocable trust to avoid probate and get around the due-on-sale clause, though, is a very good idea.