Due On Sale Clause - Misunderstood?
I have seen several conversations lately which have had some form of Due On Sale or Alienation Clause concept in them. As such I want to address the topic and provide a little opinion as well.
First let's start with the clause itself:
[b]Transfer of the Property or a Beneficial Interest in Borrower. If all or any part of the Property or any interest in it is sold or transferred (or if a beneficial interest in Borrower is sold or transferred and Borrower is not a natural person) without Lender's prior written consent, Lender may, at its option, require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if exercise is prohibited by federal law as of the date of this Security Instrument.
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 delivered or mailed within which Borrower must pay all sums secured by this Security Instrument. If Borrower fails to pay these sums prior to the expiration of this period, Lender may invoke any remedies permitted by this Security Instrument without further notice or demand on Borrower.[/b]
So there you have it, pretty straight forward if you ask me. It seems this clause in the RE world is just not that simple. To fear or not to fear? To disclose or not to disclose? Do lenders ever enforce this?
To the topic of enforcement, first let me point out the clause does not prohibit the transfer nor does the clause obligate the lender to accelerate. The right to accelerate is reserved to the lender's discretion. Additionally there is no term to which the lender has to enforce the clause, so it does not expire. (a point that we will come back to)
Secondly a common question is that of disclosure, do you report the transfer to the lender? Well within the clause there is no duty for the borrower/seller to report the transfer nor is there a duty for the buyer to report.
So then what is the big deal? Why have the clause if they do not act on it? Commonly folks site how crazy the lender would be to enforce the clause if the buyer represents performance in the form of timely payments on the debt. The lender is mostly concerned with getting paid back. Obviously the current economic climate and the lack of DOS clause enforcement speaks to that concept.
To truly understand when it is in the best interest of the lender to enforce such a clause all we have to do is look at when and why the clause came into existence. In the 1970's interest rates started to rise. The clause was written into security instruments to stifle the assumption of loans against the rise in interest rates. As an incentive to transact with a seller, if the seller had say a 7.0% interest rate they offered the assumption of their loan while new originations in the market were at 12.0% (yea, the 1980's were not interest rate friendly) This had two fundamental consequences, one was lenders were loosing control of the party responsible for payments. An assuming buyer may not be as credit worthy as the previous borrower. The second consequence was lenders not being able to recoup principal and then re-issue the principal at current market rates.
So the fight over DOS then started and was settled by an act of congress known as "Garn-St. Germain Federal Depositary Institutions Act" in the early 1980's. The act solidified the ability of a lender to enforce the DOS despite state statue to the contrary. You can view the act along with the exceptions to the rule here: http://www.law.cornell.edu/uscode/text/12/1701j-3
Following that later in the 1980's (1986 to 1989) FHA loans and VA loans established and enforced strict rules around the capability of their loans to be assumed. These loan types do not have a DOS clause and do allow for assumption. Most other residential conventional loans have the DOS clause and thus do not allow for assumption.
So now we have an idea of when and why but how does that relate today? Certainly millions of subject to transactions take place and involve real estate agents, attorneys as well as unlicensed public. The lender has two remedies in theory to the event which would be civil suite (it is not a criminal offense) and foreclosure. A lender in order to prove a civil suite against a borrower or agent or attorney would have to prove "tortious interference with contract". The layman's version of that is interfering with a contract, which is what a mortgage or deed of trust is. The problem with proving this would include a duty to the borrower to notify the lender of transfer and that duty is not present in the document or clause. Further, a counter concept to the suit would be that the borrower has multiple other options to breach their contract with the buyer aside from DOS which would include just stopping to pay and walking away.
So not too likely to see too much civil suit action around this clause. The likely and most reasonable remedy would simply be accelerate the loan and call it all due. In the event of failure to pay the lender could enforce their right to foreclose.
So to come full circle back to why very little of these clauses are enforced in today's market it starts to become a bit obvious. The large number of foreclosures in the market and the current market rate of mortgages drives the lenders away from wanting to enforce the clause CURRENTLY. A common statement amongst folks in finance, there is but one guarantee I can make and that is the market will go up and the market will go down. As long as current interest rates remain lower in relation to past rates the incentive is not high for lenders to enforce the clause. For those with foreshadowing skills, as rates rise, whenever they do, the incentive for enforcement on this clause will come back to head. Interestingly enough at that time there maybe such a large number of subject to transactions in the market place that additional concepts may have to be introduced into the Garn Act or clause as I doubt we as a nation want to go from one foreclosure pit to the next.
