Beware of "Due on Sale Clause”
Change in how title is held and transfers of ownership may accidently cause a real property loan to become immediately due and payable. A loan’s due-on-sale clause affects any transfer, but in many situations Federal law preempts the clause to protect consumers.
A real property loan’s due on sale clause protects the lender from a new owner who may not be qualified for a loan of his or her own. The clause allows the bank or financial institution to declare a loan or mortgage immediately due and payable any time real property is sold or transferred without the lender’s prior written consent.
But the due-on-sale clause is broad and includes any change in title even when ownership has not changed. The clause also includes partial changes in ownership. To prevent abuse Federal law preempts this broad application of the due-on-sale clause on residential real property containing less than five dwelling units in the following transfers.
In all other transfers the lender’s prior written consent must be obtained. This includes residential property transfers to a business entity such as a corporation, limited liability company, or limited liability partnership and lifetime transfers to any person who is not a spouse or child. Any title change or transfer in commercial property, residential real property of five or more dwelling units and apartments requires prior written consent.
The term “real property loan” means a loan, mortgage, advance, or credit sale secured by a lien on real property, the stock allocated to a dwelling unit in a cooperative housing corporation, or a residential manufactured home.
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The Federal Government Protects Family Home Trust Transfers from “Due on Sale Clause”
Trust transfers of one-to-four family properties, or single family homes are protected from the “due on sale” clause by the Garn-St Germain Depository Institutions Act (“the Act”). The Act prevents a lender from exercising its due-on-sale clause upon a transfer into an inter-vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property.
No Protection for Commercial and Apartment Trust Transfers
Commercial real property, apartment buildings and land are not protected by the Act. Any trust transfers of non-residential real estate, commercial property, apartments or land secured by a loan are considered a sale by banks. The “due on sale” clause becomes effective. To prevent the lender from exercising its right to exercise the “due on sale” clause, the owner must obtain permission in writing from the lender prior to transferring the real property to the trust.
Transfers to Business Entities
Owners of investment real estate often create a limited liability company, corporation or other business entity for liability protection from judgment creditors, “slip and fall lawsuits” and tenants. To maximize the protection of a business entity, the owner transfers the investment real property into the business entity so the business entity owns the real estate. The owner of the business entity retains ownership by owning the business that owns the real estate property.
Even transfers from an owner as an individual into a corporation or limited liability company owned by the same individual are considered sales by banks and the due-on-sale clause becomes effective. To prevent this potential problem the owner should obtain permission from the bank prior to the transfer. If the bank will not approve the owner must decide to either retain ownership as individual or look to refinance the loan with the loan in the name of the business entity.