What Is an Alienation Clause?
The term alienation clause refers to a provision commonly found in many financial or insurance contracts, especially in mortgage deals and property insurance contracts. The clause generally only allows the transfer or the sale of a particular asset to be done once the main party fulfills its financial obligation.
- An alienation clause voids certain contractual obligations to an asset if that asset is sold or if ownership is transferred to another entity.
- These clauses are common in mortgage loans, which release borrowers from the lender once the property has been transferred to a new owner.
- Alienation clauses also exist in insurance policies on any property that's been sold.
Understanding Alienation Clauses
Alienation clauses—also referred to as due-on-sale clauses—are usually a standard, especially in the mortgage industry. So it's hard to find a mortgage contract that doesn't have some type of alienation clause. Lenders include the clause in mortgage contracts for both commercial and residential properties so new buyers can't take over an existing mortgage. This ensures the lender that the debt will be fully repaid in the event of a real estate sale or if the property is transferred to another party. The alienation clause essentially releases the borrower from their obligations to the lender since the proceeds from the home sale will pay off the mortgage balance.
Alienation clauses are also called due-on-sale clauses.
They are also included in property insurance policies. In residential and commercial property insurance contracts, alienation clauses release an account holder from paying insurance on a property if property ownership is transferred or if the property is sold. This release also requires the new homeowner to obtain new insurance in their name for the property in the future.
Alienation Clause Terms
Mortgage alienation clauses prevent assumable mortgage contracts from occurring. An alienation clause requires a mortgage lender to be immediately repaid if an owner transfers ownership rights or sells a collateral property. These clauses are included for both residential and commercial mortgage borrowers.
If an alienation clause is not included in a mortgage contract, the owner may be free to transfer the mortgage debt to a new owner in an assumable mortgage contract. Assumable mortgage contracts allow a new owner to take over the previous owner’s remaining debt obligations, making the scheduled payments to the mortgage creditor under the same terms as the previous borrower. Assumable mortgage contracts are not common, however, they could be used if an owner is in fear of disclosure and does not have an alienation clause in their mortgage contract. An assumable mortgage contract can help a distressed borrower to relieve their debt obligations through a simplified transfer process.
Mortgage lenders structure mortgage contracts with alienation clauses to ensure immediate repayment of debt obligations from a borrower. Nearly all mortgages have an alienation clause. An alienation clause protects the lender from unpaid debt by the original borrower. It ensures that a creditor is repaid in a more timely manner if a borrower has issues with their mortgage payments and is unable to pay. Alienation clauses also protect a lender from third party credit risk which would be associated with a new borrower taking on an assumable mortgage contract since the new borrower has a significantly different credit profile.