What Is The Due On Sale Clause (And How To Avoid It When Buying Houses Subject-To) - powered by Happy Scribe

You know, I've talked with hundreds, maybe even as many as a thousand real estate investors over the years about subject to investing. And the one topic that's always mentioned in those conversations is the dreaded Due on sale clause. So if you don't know what this is and want to find out more about it or you do know what it is but you're not sure how to handle it, you're going to want to stick around because we are going to take a deep dive into this controversial topic and I'll let you know what the steps are that you can take to avoid this often misunderstood yet risky stipulation that exists in every single subjectto deal that you'll do in three, two, one.

Hey, guys, this is Jeff Kaufman. Before we get started, don't forget to subscribe to this channel below and then go ahead and smash that notification button to get notified every time a new video on subjectto real estate investing is uploaded to the Let's Talk subjectto channel. Let's go ahead and get started. All right, so let's talk about the do on sale clause. First of all, what is the do on sale clause?

What I'm going to do is I'm going to paraphrase it first and then I'll actually jump in and I will show you a real life example of the Due on sale clause that's actually included in a mortgage or deed of trust. Now, I am in a Deed of trust state. Some of you may be in a mortgage state, but it doesn't matter either way. The clause exists in either situation. So let me tell you what this is.

When a borrower goes out and they get a loan to buy a piece of property, there is a bunch of paperwork that's signed at closing. But amongst that paperwork will be a promissory note which is going to outline the payment terms. For example, the interest rate, the length of the loan, the monthly payment, insurance requirements, those sort of things. And then there will be a mortgage or data trust that's recorded as a lien against the property. And it's this document that provides the security for the note so that if a borrower defaults on the terms of the note, the lender can then demand the loan be paid in full invoking the provisions written in that deed of trust.

So, for example, if the borrower stops making payments, the lender can then begin foreclosure proceedings and use the deed of trust, which is their legal interest in the property, to take that property, which is also collateral for the loan that they've given, and sell it to a new buyer. The Due on sale clause is just one of several provisions just like the requirements for timely monthly payments that is found in that recorded mortgage. And here's what it means, and this is me paraphrasing. What the Due on sale clause means is that if legal title aka the deed to the subject property is conveyed to another party and it doesn't matter who that other party is, the lender has the option to call all money is due on that loan up to that point due and payable immediately. They usually give a 30 day window to get that paid.

Now, the lender can only collect what is due up to that point. So they can collect on any amounts in arrears, but they can't demand payment for any monies that they would have received for future payments or anything like that. If the borrower cannot pay the full amount to the lender after the notes call due, the lender can then begin foreclosure proceedings. So let's take a look at how it might be worded in a real, actual deed of trust or mortgage. Okay, here we are.

I have a deed of trust pulled up that I have actually used in the past. So I want to show you exactly the wording. And this may be a little bit different depending on who wrote the deed of trust but in general they're pretty much the same. The wording is pretty much the same. So if we look, I'm just going to read this to you.

I'm going to read this whole paragraph to you here and it starts off with transfer of property or a beneficial interest in borrower. And it says, as used in this section 18, interest in the property means any legal or beneficial interest in the property, including but not limited to those beneficial interests transferred in a bond for deed, contract, for deed installment, sales contract or escrow agreement. The intent of which is the transfer of title by borrower at a future date to a purchaser. If all or any part of the property or any interest in the property is sold or transferred, or if borrower is not a natural person and a beneficial interest in borrower is sold or transferred without lenders prior written consent, the lender may require immediate payment in full of all sums secured by the Security Instrument. However, this option shall not be exercised by the lender if such exercise is prohibited by applicable law.

If lender exercises this option, lender shall give borrower notice of acceleration. The notice shall provide a period of not less than 30 days from the date the notice is given in accordance with section 15, within which the borrower must pay all sums secured by this Security Instrument. If the borrower fails to pay these sums prior to the expiration of this period, lender may invoke any remedies permitted by the Security Agreement without further notice or demand on the borrower. And essentially what they're going to do is they are going to foreclose on the property. So why does due on sale even exist?

One of the reasons they exist is because in order for lenders to be able to sell these loans that they write on the secondary market, recapture those funds and then redeploy those funds on another loan they have to underwrite the original borrower and prove that the borrower can actually pay. Otherwise, the note will not perform. If titles transferred after the initial funding, there may be an issue with the lenders selling to someone like Fannie Mae and Freddie Mac on the secondary market. Now, there are exceptions to protect people from the Due On Sale Clause, and those exceptions can be found in the Garn St. Germain act of 1982.

This law outlines nine different exceptions to the Due On Sale Clause. And if you meet any one of those exceptions, a lender can't call a note due. Back in the 1980s, lenders wised up when the Fed started raising interest rates in an attempt to combat inflation. And what they did was they started calling lower interest rate loans due so that they can then take back the properties and then resell them with loans that they had written at a much higher interest rate. So the returns they were getting greater returns by calling these notes to it was definitely a predatory practice and it ultimately led to Congress enacting the Garnet St.

Germain act. So what does this all mean to you? I'm sorry to disappoint you, but all this means next to nothing for the subject to real estate investor because the invocation of the Due On Sale Clause is such a rare, rare event that even investors that have been in this space for decades have never seen a note called due. It is extremely rare. Personally, I've heard of one case where a note was called due on a property that was taken subject to the existing financing.

And in that case I actually asked for proof and verification and I never received it. What the investor did was he sent me to the foreclosure listing and upon further questioning, an investigation, I found out that what had actually happened was he had stopped making payments on that loan. So the true reason behind the note being called due was not the transfer title, but because the payments weren't being made. One other reason that might trigger the Due On Sale Clause, other than not making payments, is an improperly structured insurance policy. Normally, if an insurance policy on a subjectto deal isn't put together correctly, the lender is just going to send a notice that the policy needs to be updated with the original borrowers name listed as the insured somewhere on the policy.

Correctly setting up an insurance policy for a subject to deal is extremely important, not only to avoid garnering the attention of a lender to the transfer of legal ownership, but because you could definitely leave yourself and your seller vulnerable to tons of risk should there be a catastrophic event with the property. Insurance is a whole different discussion for another video, but I brought it up in this video because it is possible that an improperly structured insurance policy could pique the lender's interest and give the lender a reason to call the note due. One last thing before we end this video, and I want to be crystal clear here. The due on sale clause is not a law in any state, nor is it a federal law. It's simply one of the terms of the original agreement signed between the borrower and the lender.

And the invocation of the due on sale provision is entirely optional by the lender. These types of deed transfers happen every single day in this country without issue. Don't let anyone tell you that buying a house subject to is illegal because of the due on sale clause. Okay, guys, thanks so much for joining me here on Let's Talk, subject two. If you like this video, go ahead and click the like button.

And if you haven't already, please click the subscribe button as well. Don't forget to check out my other videos on the channel. Also check out my website at subtwo empire.com. All of the links related to this video can be found in the description below. And as always, thanks for watching.

We'll see you next time.