Due-on-Sale Clause

What Is a Due-on-Sale Clause?

A due-on-sale clause is a mortgage contract provision that requires the borrower to repay the lender in full upon the sale or conveyance of a partial or full interest in the property that secures the mortgage. Mortgages with a due-on-sale clause are not assumable by the property's new buyer.

Key Takeaways

  • A due-on-sale clause is a mortgage provision that requires the borrower to repay the lender in full if the property is sold.
  • By contrast, assumable mortgages allow the property's new buyer to take over the existing mortgage.
  • Even when mortgages have a due-on-sale clause, there are occasions when the lender cannot legally invoke it or may voluntarily choose not to.
  • A due-on-sale clause does not prevent property from changing hands in the event of a divorce, separation, or inheritance.
  • Most U.S. mortgages have due-on-sale clauses. The main exceptions are those loans insured by certain federal agencies.

How a Due-on-Sale Clause Works

A due-on-sale clause allows a lender to demand full repayment of a loan if the borrower sells the collateral that is used to secure their loan. This type of clause is used in home mortgages and prevents the homeowner from selling their home before paying off their debt. If the borrower attempts to sell the property without the lender's consent, the lender may foreclose upon the property.

Most mortgages issued in the U.S. include due-on-sale clauses. Prior to due-on-sale clauses, most home purchases were funded with assumable mortgages: in the event of a sale, the loan obligations would fall to the new owner. This worked to the disadvantage of the mortgage lender, especially if interest rates had increased since the origination of the loan.

Due-on-Sale Mortgage vs. Assumable Mortgage

With a due-on-sale clause, homeowners cannot transfer the mortgage to the buyer when selling their property as they could with an assumable mortgage. They must instead use the sale proceeds to pay off the mortgage, and the buyer must obtain a new mortgage on their own.

In that way, a due-on-sale clause helps protect the lender (or owner of the mortgage) from the risk that the mortgage will transfer to the new owner at a time when prevailing interest rates are higher than the rate on that mortgage. The new buyer would instead have to get a new mortgage at current interest rates.

Lenders as well as the holders of pools of mortgages such as mortgage-backed securities, asset-backed securities, or collateralized debt obligations generally favor the early retirement of mortgages with low interest rates.

If a seller attempts to circumvent the due-on-sale clause and transfer the property to a new owner without immediately repaying the mortgage, the lender can foreclose on the property and take possession of it.

Due-on-Sale Clause Exceptions

Under the 1982 Garn-St. Germain Act, lenders cannot enforce the due-on-sale clause in certain situations, even when the ownership of the mortgaged property has changed.

If there is a divorce or legal separation, and ownership between spouses changes (for example, the property was jointly owned and becomes owned by a single spouse), the lender cannot enforce the due-on-sale clause. The same is true if the owner transfers the property to their children, if a borrower dies and the property is transferred to a relative, or if the property is transferred to a living trust and the borrower is the trust's beneficiary.

A due-on-sale clause cannot prevent property from changing hands in the event of a divorce or death. Property can also be deeded to a trust, so long as the beneficiary continues to live in the house.

Why Would a Lender Not Invoke a Due-on-Sale Clause?

Even if the lender is legally entitled to invoke a due-on-sale clause, there can be situations in which it may elect not to. For example, in a weak housing market, it might be advantageous for the lender to allow a new buyer to assume the old mortgage rather than risk the possibility that the original borrower will default on it.

Or, if the home has declined significantly in value, and its sale doesn't bring in enough money to cover the debt, the lender might accept less than the full payment in order to recoup at least a portion of what it is owed.

Example of Due-on-Sale Clause

Imagine a hypothetical couple, Alan and Beth, who co-own a home with a $100,000 mortgage. This mortgage has a due-on-sale clause, meaning that if the couple sells their home, they may have to repay the full balance of their mortgage.

After several years, Alan and Beth divorce, and Beth becomes the sole owner of the home. Since they were spouses, the transfer does not trigger the due-on-sale clause: Beth can assume full ownership of the home, and continue paying the original mortgage.

The next year, housing prices increase, and Beth decides to sell the home to Charlie. Since Charlie is not covered by any exception, Beth must be able to repay the remaining balance on the mortgage upon closure of the sale. Depending on the housing market at the time of the sale, the lender may or may not choose to enforce the due-on-sale provision.

What Types of Mortgages Do Not Have a Due-on-Sale Clause?

Most institutional mortgages issued in the United States have due-on-sale clauses. The most common exceptions are loans insured by the Federal Housing Authority, the Department of Veteran's Affairs, or the Department of Agriculture. Each of these agencies requires the new buyer to meet certain conditions before assuming the loan.

Do Wrap-Around Loans Have a Due-on-Sale Clause?

Wrap-around mortgages are loans that include the full balance of an older loan that has not been fully paid off. These are frequently used in home sales, where the seller collects payments from the new buyer to pay off the wrap-around mortgage. If the original mortgage includes a due-on-sale clause, the entire balance becomes due on the sale of the house.

Do FHA and VA Loans Have a Due-on-Sale Clause?

Loans that are insured by the FHA, VA, or USDA do not have due-on-sale clauses, meaning that new buyers can assume the prior owner's mortgage obligations when they purchase a property. However, all three agencies have specific requirements about who is eligible to assume these loans.

Is There a Due-on-Sale Clause When the Property Is Gifted?

A due-on-sale clause can be triggered any time the ownership of a property changes, at the discretion of the seller. The main exceptions relate to property transfers between spouses, inheritance, or to living trusts where the beneficiary is the borrower. Unless a mortgage property is gifted to the borrower's spouse or children, giving the property as a gift could trigger the due-on-sale clause.

Will a Quitclaim Deed Trigger a Due-on-Sale Clause?

Quitclaim deeds are frequently used to transfer property without an exchange of money, as might occur between family members. However, such transfers may cause trouble if the property is mortgaged with a due-on-sale clause. If a property is transferred through a quitclaim deed, and the parties are not related in a way that gives them an exception, then the original owner could be on the hook for the full value of the loan.

Article Sources
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  1. U.S. Code. "Title 12—Banks and Banking § 1701j–3," Page 439.

  2. U.S. Department of Housing and Urban Development. "HUD 4155.1, Chapter 7. Assumptions."

  3. U.S. Code. "Title 12—Banks and Banking § 1701j–3," Page 440.

  4. National Archives, Code of Federal Regulations. "Title 7, Part 3555 - Guaranteed Rural Housing Program."

  5. U.S. Department of Veteran Affairs. "VA Pamphlet 26-7, Revised Chapter 3: The VA Loan and Guaranty," Page 26.

  6. National Archives, Code of Federal Regulations. "Title 26 § 15a.453-1 Installment Method Reporting for Sales of Real Property and Casual Sales of Personal Property."

  7. U.S. Department of Veteran Affairs. "VA Pamphlet 26-7, Chapter 5 How to Process VA Loans and Submit them to VA," Pages 25, 29.