Due-on-Sale Clause

A due-on-sale clause is a stipulation in your mortgage contract that requires you to pay off the remaining balance of the loan if you sell your property before fully paying off the mortgage. It’s sometimes referred to as an acceleration clause. 

 

What is a due-on-sale clause?

Let’s say Nico and Milo purchase a home with a mortgage loan. Two years later they decide to sell the property to a new buyer, Sam.

If Nico and Milo had signed a due-on-sale clause when they bought their house, it means that the couple will have to use the money from the sale to pay back the remaining balance on the mortgage—which includes the principal loan amount and any interest they owe on the home loan. They won’t be able to simply pack up, transfer the mortgage to Sam, and drive off into the sunset. 

The due-on-sale clause ultimately protects the lender from below-market interest rates. By asking for the full mortgage amount at sale, the lender gets a full return on their investment. The new buyer of the home will have to take out a new mortgage with a new interest rate, based on today’s market interest rates.

BTW, the opposite of a due-on-sale clause is called an ‘assumable mortgage.’ This means the new buyers can take on the terms of the mortgage held by the current owners. If you ‘assume,’ or take on, someone’s mortgage, it means you’re agreeing to take on their debt, and continue paying where the previous homeowner left off.

Assumable mortgages are desirable when the terms currently available to a buyer are less attractive than those previously given to the seller.

Example of a due-on-sale clause

After paying down their mortgage for five years, Nico and Milo have around $250,000 left on their $300,000 mortgage. The couple have decided to sell their house, and they get an offer for $325,000, which they accept.

Because they’ve signed a due-on-sale clause as part of the mortgage contract, they pay their lender the $250,000 of the remaining balance, and can bank the remaining $75,000 from the sale of the home. All’s well that ends well. 

Let’s say the couple wanted to try and game the system and pass off their current mortgage without the lender’s consent (not a good idea). Mortgage lenders are automatically notified when a property they’ve helped finance transfers ownership. When the lender learns that the property was sold before the remainder of the mortgage was paid back, they have the right to foreclose on the home. That’s the due-on-sale clause in action.

Do all mortgages have a due-on-sale clause?

Most, but not all, mortgages have a due-on-sale clause. Some types of mortgages are assumable, like VA, FHA, and USDA loans. 

Example of an assumable mortgage

If Nico and Milo’s mortgage was a VA loan, and they had $250,000 left on their $300,000 mortgage, they could potentially transfer their mortgage to a new buyer. The new buyer would still need to qualify for that mortgage by meeting credit and income requirements. The new buyer could essentially continue paying down the loan where the original owner left off. 

Assumable mortgages are especially appealing when real estate market interest rates are on the rise. A new buyer could essentially inherit a lower interest rate and an attractive mortgage contract without jumping through bureaucratic hoops or filling out tons of loan documents to get a new loan. 

Are there exceptions to a due-on-sale clause?

Even if you signed a due-on-sale clause as part of your mortgage contract, there are a few specific exemptions that wouldn’t require a borrower to pay off the mortgage balance at sale: 

  • Divorce or legal separation: If the borrower files for divorce or legal separation, the property can be transferred to a spouse or child. 
  • Inheritance: If the original borrower dies and names a relative as the inheritor of the property, the due-on-sale clause would not be invoked.
  • Living trust: If the property is moved into a living revocable trust (which FYI, does technically change the ownership of the property) and the borrower is named as the trust’s beneficiary, it doesn’t put the due-at-sale clause into effect. 

Please note that these exceptions to the due-on-sale clause only apply when the spouse, child, inheritor, or beneficiary in question choose to live on the property. If they choose to rent or sell the home, the due-on-sale clause would kick right back in. 

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