Due on Sale Clause – Definition

Cite this article as:"Due on Sale Clause – Definition," in The Business Professor, updated September 30, 2019, last accessed May 26, 2020, https://thebusinessprofessor.com/lesson/due-on-sale-clause-definition/.

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Due-on-Sale Clause Definition

A due-on-sale clause or an acceleration clause is a specification in a mortgage contract that requires a mortgage borrower to pay the balance due before the sale of the property securing the mortgage. Acceleration clauses protect lending institutions by allowing them to call or accelerate a loan payment process when the borrower starts violating the terms or missing payments.

The due-on-sale prevents the new buyer of the property from taking over the mortgage with its original interest rates. Banks and mortgage lenders allow the new buyers of properties with due-on-sale clauses to negotiate new interest rates.

A Little More on What is Due-on-Sale Clause

Before transferring the property to a new owner, the previous owner should obtain consent in writing from their lender. One cannot assume due-on-sale clauses since the lenders will not allow the buyer to take over the current mortgage.

A due-on-sale clause protects the mortgage holder and the lender from the risk of the mortgage going to a new owner of the property at rates lower than the current market rates. Transferring mortgages at low prices always end up extending the life of the mortgage payment plan.

Therefore, when someone has a property on mortgage, they have to clear the mortgage using sale proceeds before selling it to the new owner. The new buyer should then obtain a new mortgage from the lending institution.

Lenders also take advantage of the rising interest rates to impose due-on-sale clauses on property owners. If a lending institution feels that it can make money from the high-interest rates, then it may enforce the clause on the owner.

The lender then gets a new buyer who obtains the mortgage at higher interest rates, which benefits the lender in the end. Some banking institutions use the due-on-sale clause when the property securing the mortgage is at risk.

Exceptions of the Due-on-Sale Clause

The Garn-St. Germain Act of 1982 states that a mortgage lender cannot impose the due-on-sale clause on the mortgage in case ownership of property changes. For example, a couple has joint ownership over the property, and they divorce or separate legally. The lender exempts the single spouse who assumes property ownership from the due-on-sale clause.

In case someone inherits the property on mortgage and lives in it, the lending institution cannot put into effect a due-on-sale clause. The exception also applies when the property owner dies, or when he/she transfers the ownership to their children or relatives.

A lender can also exempt a property owner from a due-on-sale clause when the market condition of the real estate collapses, causing the lender to incur losses. In such cases, the lender may take on any offer from potential property buyers to recover their losses.

 Home Loans without a Due-on-Sale Clause

VA, FHA, USDA loans are all examples of mortgage contracts that do not have a due-on-sale clause in them. The loans are also known as assumable mortgages since the lenders allow transfers of property from one individual to another. The new owner takes over the existing loan and continues with the repayment plan of the seller. However, there are some qualifications that the buyer must meet to take over the mortgage.

Conclusion

The main function of the due-on-sale clause is to protect the banks and other lending institutions from losses in case the property owner is unable to clear their mortgage payment. The clause also prevents the property owner from transferring ownership to a buyer who might later default on payments.

Rather, the owner needs to clear their mortgage using proceed sales, and the new buyer must take on a new mortgage loan. Before signing the dotted line on the mortgage contract, the borrower should ensure they understand how the due-on-sale clause works.

Reference for “Due-on-Sale Clause

https://en.wikipedia.org/wiki/Due-on-sale_clause

https://www.investopedia.com › Personal Finance › Mortgages

https://www.thebalance.com › … › Home Buying › Market Facts & Trends

https://www.bankrate.com › Glossary › D

www.businessdictionary.com/definition/due-on-sale-clause.html

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