When a subject-to deal requires lender approval

What is a due-on-sale clause?

A due-on-sale clause, also known as an alienation clause, is a provision in a mortgage contract that allows the lender to demand full repayment of the loan if the borrower sells or transfers the property. This clause protects the lender's interest.

Most conventional mortgage loans include this clause. It prevents a new owner from simply taking over an existing, often lower-interest, mortgage without the lender's consent.

How the due-on-sale clause works in practice

In a subject-to transaction, the deed to the property is transferred to you, but the original mortgage remains in the seller's name. This transfer of ownership technically triggers the due-on-sale clause.

However, lenders often don't enforce this clause immediately or for every transfer. They might not discover the transfer, or they may choose to overlook it as long as payments are made consistently and on time.

If the lender does discover the transfer, he or she has the right to demand the entire loan balance be paid immediately. This is the primary risk associated with subject-to deals.

Situations where a lender might enforce it

Lenders are more likely to enforce a due-on-sale clause if interest rates have risen significantly since the original loan was made. They might want to get the old loan off their books and issue a new one at a higher rate.

Another trigger can be a default on payments or if the property becomes distressed or unmaintained. Lenders are primarily concerned with minimizing their risk.

While residential mortgages are often the focus, some commercial loans might have similar provisions that are more strictly enforced. Always review the specific loan documents.

Identifying a due-on-sale clause in loan documents

To determine if a mortgage has a due-on-sale clause, you need to review the original mortgage or deed of trust document. This is a publicly recorded document, usually available through the county recorder's office.

Look for language that mentions 'sale,' 'transfer,' 'alienation,' or words to that effect, often stating that the lender may accelerate the loan upon such an event. If you are unsure, have a real estate attorney review the documents for you.

Mitigating the risk without formal approval

Many investors structure subject-to deals by maintaining consistent, on-time mortgage payments to avoid drawing the lender's attention. The goal is to keep the loan in good standing.

Transparency with the seller about the risks is also key. He or she needs to understand that the mortgage remains in his or her name and that communication with the lender is critical if any issues arise. This is not legal advice, so consult with an attorney to ensure your deal structure is compliant and protects both parties.

Disclaimer

This information is for educational purposes only and is not intended as legal or financial advice. Subject-to transactions involve complex legal and financial considerations.

Always consult with a qualified real estate attorney and financial advisor to understand the specific risks and legal implications in your jurisdiction before engaging in a subject-to deal.