The Due-On-Sale Clause: Exemptions are Limited; Liability is Not

If you own a home with a mortgage, then you need to know about 12 U.S. Code Section 1701j-3.

More commonly known as the Garn-St. Germain Act, this federal law contains a list of exemptions from a due-on-sale clause for the sale of residential real property.

A due-on-sale clause is a tricky little provision that authorizes a lender to accelerate payment of a note if the collateral is sold without the lender’s written consent.  Most home mortgage documents contain a due-on-sale clause.

Garn-St. Germain prohibits a lender from accelerating a note under a due-on-sale clause for the following situations:

  • Death of the borrower if it results in the house being transferred to a relative.
  • Creation of a junior lien in the property, if there is no change in the right to occupy the property.
  • Creation of a purchase-money security interest for household appliances.
  • Transfer by devise, descent or operation of law on the death of a joint tenant or tenant by the entirety.
  • Leasing the property for no more than 3 years, provided the lease does not include a purchase option.
  • Transfers where a spouse or child of the borrower becomes an owner of the property.
  • A transfer to a spouse because of a divorce.
  • A transfer to an inter- vivos trust as long as the borrower is and remains a beneficiary and the right to occupy the property does not change.
  • Any other transfer or disposition described in Federal Home Loan Bank Board regulations.

As you can see, the list is fairly short.  As a result, it is amazingly easy to run afoul of a due-on-sale clause.

One common problem transaction is selling a property “subject to” a mortgage.

In this type of transaction, the seller deeds the property over to the buyer in exchange for the buyer agreeing to make mortgage payments.   The entire transaction is kept secret from the mortgage company.   For the seller, the hoped-for result is relief from the mortgage payments and getting improved credit because the buyer’s payments will be reported on the seller’s credit report.  For the buyer, the advantage is getting property without having to qualify for a mortgage.

Oh, but the downside!

Let’s imagine that the seller wants to buy another property, he or she may not qualify because of the existing mortgage debt.  The mortgage could company find out about the secret sale,  they can then accelerate the loan under the due-on-sale clause and then foreclose on the property.  If the buyer fails to make the mortgage payments, then the seller’s credit is dinged and the property will be foreclosed upon.  If the seller, who is still listed as the borrower, dies or goes into bankruptcy, the mortgage company can, again, declare a default and foreclose.

As far as keeping the transaction a secret, Texas has a law that makes that a bit difficult.

The seller is required to give the buyer and lienholder a written disclosure.  The wording and exceptions to the requirement can be found in Section 5.016 of the Texas Property Code.