|There is No Due on Sale Jail
The "due-on-sale" clause is probably the most talked about, feared and misunderstood topic
in real estate. This article will dispel any misunderstandings you may have about the due-on-sale
and suggest a simple, yet effective strategy to get around it
What is the Due-on-Sale Clause?
Before we discuss how to get around the due-on-sale, we must understand what it is and where it
came from. The due-on-sale (a.k.a "acceleration clause") is a provision in a mortgage
document which gives the lender the right to demand payment of the remaining balance of the loan
when the property is sold. It is a contractual right, not a law. This means that if title to the
property is transferred, the bank may (or may not), at its option, decide to "call the loan
An "assumable" loan is one which is secured by a mortgage which contains no due-on-sale
provision. FHA-insured mortgages originated before 12/89 and VA-guaranteed loans originated
before 2/88 contain no due-on-sale provisions. Nearly all loans originated today contain
a "standard" due-on-sale clause which usually reads something like:
- "If all or any part of the property herein is transferred without the lenders prior
written consent, the lender may require all sums secured hereby immediately due and
Where Did the Due-on-Sale Dilemma Come From?
Banks began inserting due-on-sale clauses in their mortgages in the 1970s when interest rates rose
dramatically. Home buyers were assuming existing loans rather than borrowing new money from banks
because the interest rates on existing loans were lower. The banks used the due-on-sale as a way to
kill their own worst competition. They argued that the reason for the restriction was to be
able to police who was living in the property, the collateral for their loan. This argument
holds little water, since most banks haven't been enforcing due-on-sale violations since the early
80's when interest rates were high. In fact, Black's Law Dictionary defines the due-on-sale
clause as a device for "preventing subsequent purchasers from assuming loans with lower than
market interest rates." This idea was also confirmed by the Court in Community Title Co v.
Roosevelt Savings & Loan 670 S.W.2d 895 (Mo.App. 1984): "The due-on-sale clause was
a way of eliminating these low yielding loans as soon as the property was sold, so that it could
re-loan the money at current higher rates or negotiate a higher rate in the event the purchaser
assumed the existing loan."
The homeowners fought the banks in court claiming that the enforcement of the due-on-sale was
"unfair trade practice" and an "unreasonable restraint on the alienation of
property." In state courts, many homeowners were winning the argument. See, e.g.,
Wellenkamp v. Bank of America, 21 Cal 3d 943 (1978). The banks ultimately won in a United
States Supreme Court case, Fidelity Federal Savings and Loan Association v. de la Cuesta,
102 S.Ct. 3014, (1982). Congress thereafter passed the "Garn-St. Germain Federal
Depositary Institutions Act" (12 U.S.C. 1701-j) which codified the enforceability
of the due-on-sale clause, despite state statute or case law to the contrary.
There is No "Due-on-Sale Jail"
Many people are under the mistaken impression that transferring title to a property secured by a
"due-on-sale" mortgage is illegal. This is because most lay people confuse civil
liability with criminal liability. To be "illegal," you must be in violation of a
criminal law, code or statute. There is no federal or state law which makes it a crime to
violate a due-on-sale clause. If the lender discovers the transfer, it may at its option,
call the loan due and payable. If it cannot be paid, the lender has the option of commencing
So the real question is: are you willing to take a property subject to a mortgage containing a
due-on-sale clause with the risk of getting caught?
The "Trust-Assignment Trick"
The game for us is how to transfer ownership to the property without getting caught by the
lender. You could simply get the owner to sign you a deed and not record it, but this method is
problematic (for example, what if the seller gets a judgment against him?). Enter the "trust
assignment trick . . .
The Garn St. Germain Act carves several exceptions in which the lender may not enforce the due-on-sale
Exemption of Specified Transfers or Dispositions
With respect to a real property loan secured by a lien on residential real property containing
less than five dwelling units, including a lien on the stock allocated to a dwelling unit in a
cooperative housing corporation, or on a residential manufactured home, a lender may not exercise
its option pursuant to a due-on-sale clause upon -
(1) the creation of a lien or other encumbrance subordinate to the lender's security instrument
which does not relate to a transfer of rights of occupancy in the property;
(2) the creation of a purchase money security interest for household appliances;
(3) a transfer by devise, descent, or operation of law on the death of a joint tenant or tenant
by the entirety;
(4) the granting of a leasehold interest of three years or less not containing an option to purchase;
(5) a transfer to a relative resulting from the death of a borrower;
(6) a transfer where the spouse or children of the borrower become an owner of the property;
(7) a transfer resulting from a decree of a dissolution of marriage, legal separation agreement,
or from an incidental property settlement agreement, by which the spouse of the borrower becomes
an owner of the property;
(8) a transfer into an inter-vivos trust in which the borrower is and remains a beneficiary
and which does not relate to a transfer of rights of occupancy in the property; or
(9) any other transfer or disposition described in regulations prescribed by the Federal Home Loan
(The Federal Home Loan Bank Board, which was disbanded in 1989 and replaced by the Office of Thrift
Supervision, takes the absurd position that the Act only applies to owner-occupied homes.
See 12 C.F.R. 591. However, the clear language of Garn Act specifically
states that it applies to residential one-to-four family homes. There is no mention that it must
be "owner-occupied." Although never enforced or challenged, such a direct conflict
with the Congressional statute would probably be struck down in court as being "ultra vires").
The Land Trust.
A land trust is form of a revocable,
living trust which is exempted under the Garn Act. A land trust, like a living trust, is create
by two legal documents:
- A trust agreement between the creator (called "grantor" in legal terms) of the trust and
the trustee which defines the trust arrangement; and
- A deed from the creator of the trust to the trustee.
The trustee holds title for the benefit of the grantor (in this case, the grantor is also the
"beneficiary"). If you place title to your property into a land trust, you have not violated
the due-on-sale (so long as there is no change in occupancy).
Let's say that you come across a seller who is willing to give you title to his property. The only
"glitch" is that the loan is not assumable because the mortgage has a due-on-sale clause.
Here's the process for getting around it:
- STEP 1: Sammy Seller signs a trust agreement with you as trustee of his trust. Sammy is
named as the "beneficiary" of the trust.
- STEP 2: Sammy Seller transfers title to the trustee (no violation of the due-on-sale clause)
- STEP 3: Sammy Seller quietly assigns his interest under the trust to you (similar to a transfer
of stock in a corporation). This assignment is not recorded in any public record. Sammy moves out
and you move in
- STEP 4: You are now the beneficiary of the trust. Your trustee makes payments to the lender.
Keep in mind that the assignment of Sammy Seller's interest under the trust to you does trigger
the due-on-sale, but who is going to tell the lender? In reality, the lender will discover the
transfer of an interest in real estate in one of three ways:
- Change of name on the deed. Not likely, since lenders don't readily have "spies" at
the clerk's and recorder's office;
- Different name on the check received for payment. Not likely, since the bank officers are far
removed from the clerical workers who process payments; or
- Change of hazard insurance beneficiary. This is the most common way a lender discovers a
transfer of interest in the borrower's property.
If you notify your insurance carrier of a change in insurance beneficiary, the lender, who is also a
named beneficiary, receives a copy of the change. However, if you transferred title into a land trust,
the new beneficiary under the insurance policy will be the trustee of the land trust. The lender
will probably not object, since it will assume the seller has implemented an estate planning device.
If the beneficiary of the trust is assigned, the lender will not be notified since the insurance
beneficiary (the trustee) has not changed.
This strategy is not much different than simply transferring title directly from seller to buyer
(called taking a deed "subject to"). However, the chances of the lender discovering
the change of ownership are greatly reduced. This is especially true where the lender has
contracted to use a "servicing" company to deal with most facets of the loan. If
you have had any experience with servicing companies, you may know that most are so poorly managed
that they don't know which way is up (I would wager that a survey of 100 servicing company employees
would reveal that 98 of them wouldn't know the meaning of a due-on-sale clause).
But, but . . . isn't It is Unethical or Fraud?
From a legal standpoint, a real estate agent who does not disclose the transfer to the lender has
committed no breach of ethics. In fact, some of the standard contracts approved by the
California Association of Realtors contain provisions contemplating a "subject to"
transfer (see, e.g., form LRO-14, Residential Lease with Purchase Option). The Offical
Utah Division of Real Estate forms also contain provisions for transfers in the face of a due-on-sale
Seller Financing Addendum to REPC). According to the New York Department of Real Estate,
it is not improper for an agent to suggest a lease/option or contract-for-deed, both of which
trigger the due-on-sale.
The state bars have no problem with lawyers helping clients conceal a transfer either. In
Matter of Sabato, 560 N.E.2d 62 (Ind. 1990), the court found no ethical problem with an
attorney helping a client circumvent a due-on-sale provision using a land trust as described above.
In Alaska Bar
Association Ethics Opinion #88-2, the Committee declared "circumventing a contract term
under these circumstances is not fraud or fraudulent conduct. The attorney's participation
would amount to concealing a breach of contract." The Illinois Bar also concluded that
"the breach of the contract of sale in contravention of the due on sale clause is not a crime"
See Advisory Opinion No. 728. The Virginia Bar reached a similar conclusion in Opinion 471
Thus, if it is not illegal or fraud for an attorney or broker to conceal a transfer of ownership, it
is certainly not for a lay person. It is not a bad idea, however, for any party or real estate
agent to disclose the existence of a due-on-sale clause to all parties involved in the transaction so
that they are aware of the risk. Utah Rule R162-6.2.14 states "Real estate licensees have an
affirmative duty to disclose in writing to buyer and sellers the existence or possible esistence of
a "due-on-sale" clause in an underlying encumbrance on real property, and the potential
consequences of selling or purchasing a property without obtaining the authorization of the holder
of the underlying encumbrance" (note that the rule does not prohibit such transactions). In
Ethics Opinion No. 96-2, the Alaska Bar ruled that an attorney has no duty to disclose the existence
or the implications of a due-on-sale to parties to a transaction whom he was not representing
(personally, I disagree with this ruling; I think an attorney should disclose, even if it runs him the
risk of giving out unsolicited legal advice).
Some title company representatives and attorneys have refused to close "subject to"
transactions, quoting 18 United States Code Section 1001, which generally states that:
"whoever, in any matter within the jurisdiction of the executive, legislative, or judicial
branch of the Government of the United States, knowingly and willfully -
- falsifies, conceals, or covers up by any trick, scheme, or device a material fact;
- makes any materially false, fictitious, or fraudulent statement or representation; or
- makes or uses any false writing or document knowing the same to contain any materially false,
fictitious, or fraudulent statement or entry; shall be fined under this title or imprisoned not
more than 5 years, or both.
It is a bit of stretch to apply this law to concealing a transfer that triggers a due-on-sale
clause. Taken to its illogical extreme, this statute could land you in jail for
saying "I'm next" while on line at the post office when you really aren't. In
fact, criminal statutes are always narrowly construed to protect the rights of citizens.
18 U.S.C. Sec. 1010 makes it a crime to make any false statement in regard to a loan insured
by HUD. This law has been used to prosecute borrowers and their brokers who lie on their loan
applications or "fudge" down payments for FHA loans. It has never been used
to prosecute due-on-sale violators. In fact, the HUD-1 Settlement Statement (lines 203 and 503) that
is used for virtually every loan closing has a blank which states, "loans taken subject
to." How could a HUD promulgated closing form contain such a blank if it were a crime to
take property subject to an existing loan?
Remember that the due-on-sale is triggered by "transfers" other than a deed. A lease
of three years or more, a lease/option of any term, a contract for deed (except on VA-guaranteed
loans), moving out of the property within the first year and other transactions also give the lender
the option to call the loan due. Thus, hundreds of thousands of borrowers across the country
could be subject to prosecution. Furthermore, their real estate agents, attorneys, insurance
agents, title companies and others could be indicted for conspiracy - LOL (laughing out
There have been no reported cases of criminal prosecution for violation of the due-on-sale. In
fact, the Federal Tax Court recently
reviewed a case in which
the taxpayer had taken title to 10 properties "subject-to" existing mortgages. If ever
there were a case for federal prosecution, it would have been in a federal forum!
In theory, a lender could sue the borrower for fraud for deliberately making a misstatement regarding
his loan. Of course, this makes no sense, because a lender would do better simply calling the
loan due and foreclosing the property. Furthermore, a case for fraud requires someone to lie in
the first place; keeping your mouth shut is the easiest way to avoid the issue.
In theory, a lender could sue you, the buyer, for inducing the seller/borrower to breach his mortgage
agreement (called "tortious interference with contract"). This case would be pretty
hard to make, since the standard mortgage agreement does not state that the borrower has to notify
the lender if he transfers title or any other interest in the property. Odly enough, I did find one
reported case in which the lender tried to make such an argument: Community Title Co v. Roosevelt
Savings & Loan 670 S.W.2d 895 (Mo.App. 1984). In that case, a lender (Roosevelt Savings)
sued a title company that advocated, educated and performed closings using a contract-for-deed.
Some of the properties that were closed had Roosevelt's mortgages, which contained due-on-sale
provisions. The court correctly reasoned that the title company was not liable, since the
borrowers could have found some other means of violating the due-on-sale (in legal terms, there was
no "but for" causation). Likewise, it would be just as easy for you to prove that the
borrower was inclined to walk away from the property and default on the loan . . . why else would
he hand you a deed subject to his mortgage?
Of course, all of this discussion of "fraud" requires a material misstatement of fact in the
first place. If anyone made a misstatement, it was the borrower (ok, so it was your idea - so
what?). If the borrower and you simply transferred title without making any statements to the
lender (as I described above), then there can be no fraud. The United States Supreme Court
recently declared that is not fraud to violate a due-on-sale if the borrower simply transfers title
without saying anything to the lender. See Field v. Mans, 1995.S.Ct.207 (1995).
Furthermore, the court in Medovoi v. American Savings & Loan, 89 Cal.App.3d 875 (1979)
declared a lender could not sue the buyer for fraud for deliberately concealing a transfer, since
he has no legal obligation to tell the lender of the transfer.
Don't Just Take My Opinion
Thus, beyond the legalities, "ethics" becomes a matter of opinion. In other words, is
it dishonest? About opinions, the legendary Dirty Harry eloquently stated "an opinion is
like an a**hole . . .everyone's got one." Joking aside, the following are some prominent
professionals' opinions the subject.
Attorney Robert Bruss, a well-respected nationally syndicated real estate columnist, advocates the
practice transferring properties "subject-to" existing loans without notifying the
lender. In his 1998 article, "Nothing Down Home Purchases," Bruss says, "I
buy subject to the existing mortgage and do not notify the lender of my purchase . . . In today's
market . . . a lender would be crazy to push the issue and put the loan into default." In
his article, "The Six Pillars of Assumption," he also advocates the use of a
trust to "dupe" the lender.
Attorney Jeffrey Liss, J.D., LLM, a Harvard Law School Graduate and well-respected member of the
Illinois Bar, wrote an excellent article called "Drafting Around the Mortgage 'Due on Sale'
Clause in the Installment Sale of Real Estate" which was published in the Chicago Bar
Record in 1981. In this article he points out that "the mortgage does not prohibit
the [transfer], but merely gives the mortgagee an option to accelerate. There is no duty upon
the seller/mortgagor to report such a sale. The attorney, therefore, is not counseling any
breach of contract or breach of a business relationship."
If you think that concealing a due-on-sale transfer from a lender is dishonest, consider the
following lender practices . . .
- Yield spread premium "kick-backs" (recently declared RESPA violations by at
least three federal courts - see, e.g., Culpepper v. Inland Mortgage, 132 F.3d 692 (1998))
- $100 "processing" fees for loan payoff (declared unenforceable by a
Florida Federal District Court in Sandlin v. Shapiro 95-213-Civ FtM-17D (M.D. Fla 1996)).
- "Stalling" for loan payoff statements to obtain additional interest (a
common practice by several lenders in my personal experience in closing scores of loan transactions)
- The old "bait and switch" with loan rates - promising one rate then
changing it the day before closing because of alleged "underwriting requirements"
- Charging $85 for a credit report that costs the lender about $5
- Offering a loan with no points, then charging $500 for "Administrative
My point here is not to convince you that banks are evil. Like the Godfather says,
"it's just business." Taking title to a property subject to an existing loan . . .
it's also "just business." It makes more financial sense in many cases than
plunking down a 20% down payment, paying loan costs and signing personally on a note. It
is a calculated risk that, in many cases, is worth taking. It also makes more financial
sense for a lender to ignore a due-on-sale violation than to incur costs in foreclosing a
property. This is especially true if the loan is already in default and there is little
equity in the property, such as in a foreclosure situation.
The Reality of the Marketplace
In most cases, lenders today are not concerned with violations of due-on-sale clauses on
performing loans. There is no financial incentive for a lender to enforce a due-on-sale
provision on a performing loan if market interest rates aren't any higher. A lender does
not want non-performing loans in its portfolio - it simply looks bad. This trend will
probably continue so long as interest rates remain within a few percentage points of existing
UPDATE 8/1/2001: I have been receiving reports that Countrywide Home Loans has been enforcing
the due-on-sale clause, even on performing loans! Solution: stay away from Countrywide Loans.
Copyright 1998 All Rights Reserved. No part of this publication may be copied
or reprinted without the express written permission of the Author.
William Bronchick, Esq.
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