Due on sale clause was called by bank!

132 Replies

I wanted to share a recent experience. I recently received a letter from one of my lenders (Flagstar bank) calling out a deed transfer I made around 2-3 years ago. I transferred a deed via quitclaim from my name into an LLC. The loan was secured in my name as it was one of my first 4 Fannie loans. They noticed that I had a named insured of my LLC added to my insurance. They first demanded that my insurance carrier change the named insured back into my name. Then I received a letter invoking the due on sale clause with a copy of the deed. They are giving me 30 days to transfer it back into my name and change the insurance accordingly. They will not accept mortgage payments in the mean time.

Wow - this is the first I've heard of a bank invoking the due on sale and it happened to me. I've made every payment on time with no issues. This gets me thinking of all the people that buy homes subject to the original mortgage. This situation would be an absolute nightmare if I had to unwind a transaction years later. I don't see how this could be a sustainable model with the due on sale threat constantly out there. All you hear is that the bank will never call the due on sale clause. Well it does happen.

At our local meetup on Thursdays for lunch I have heard of Wells Fargo calling several notes from several investors.  It is happening more often of late.  Don't believe the people that tell you to ignore this risk.  It does happen!

Transfer the property back into your name, create a land trust and place property into land trust. Make LLC beneficiary of land trust. Problem solved! A land trust helps avoid "due on sale" clause, transfer taxes, probate, and keeps your real estate holdings private. Google land trust and do your own research, but I am certain you will find that this is the solution to your problem. Look up Mr land trust Randy Hughes to get more education. Contact a real estate attorney who specializes in land trusts asap. Best of luck.

When we were figuring out the LLC versus umbrella route several years ago, the reason we did not go the LLC route even though recommended by our real estate attorney at the time (no longer) was that when I called our lenders, they told me they would not allow it and would call it if they were made aware of it, no matter what our attorney was saying. I know many take the risk and get by with it every day, but I always seem to get called out on things, some sort of rule magnet -- a PITA but I've learned a lot over the years dealing with some very weird issues. I believe it's a much more strict environment for lenders now when they try to package their loans and sell them, and likely can't sell them off if they don't meet standards, so I assume it's going to get more commonplace in the future.

@Serge S. Have you been able to determine why they are calling?  @Dion DePaoli has said perhaps the biggest risk is the lender selling packages of loans and this is caught in the due diligence of the sale. 

Perhaps Dion can reply to this question. Why doesn't the bank drop the one note from the pool being sold?

I wonder if it is a bluff. Would a bank really foreclose on a performing note? I wonder if a counter bluff would be effective. "I can drag this out for three to five years and you know it. Do you really want to go through all that trouble to foreclose on a performing note?"

Bankers might be a bit slow, but they're not stupid.  Maybe they're catching on.

Originally posted by @Dana Whicker :

Bankers might be a bit slow, but they're not stupid.  Maybe they're catching on.

Hmm I don't know about that. It is stupid to call a performing loan. The banks position does not change one iota with a transfer. The original guarantor is still liable for the note and the property is still collateral.  (OK the ability to sell that note may have changed, but that is only because the next person in line is being stupid)

But I do agree they are catching on to investor strategies. They are just being stupid in reaction to them.

stop paying, gut the house/sell everything of value, break their loan obligation in bankruptcy, see how they feel then.

@Serge S.

Thank you for sharing... Have been hearing about this a lot more in the North East as well....

@Ashley Pimsner

 I do believe you have it right but should have been done before the call. Not sure it can be now and if it would hold up.......Def a very sharp R/E land trust & Asset Wealth attorney needs to be consulted...

@Ned Carey - while I agree in part that it doesn't make sense that they foreclose on a performing note, technically, it is likely not "performing" because of the deed transfer, it is likely, in fact, to be considered in default because the original borrower @Serge S. didn't live up to the obligations in the original contract, which is exactly what the note and mortgage are.

This is a very unfortunate situation indeed and I would say consulting an attorney should be done ASAP.  I would also refer back to the original documents (note and mortgage) and learn what happens in the event of default, as far as who pays for remedies.  My guess is that it could get ugly (and expensive) for Serge if he chooses to "dig in" and fight them on it.

While many may argue on the way that it SHOULD be, the fact is, there is a written contract that has been breached.  When a contract is signed, the terms are what they are and signing means that you agree to live by them.  I will leave it for the attorney to fill in the blanks as to what happens next.

This is a very good reason why I avoided using Fannie/Freddie guideline mortgages to finance properties that I own. They were to be titled in an LLC, I knew this ahead of time. I used portfolio lenders that DID allow them to be titled in an LLC from day one. My financing costs me a little bit more, but I sleep at night.

Others have mentioned land trusts, which I have no experience with so I can't speak to that idea.  Please keep us posted.  Thank you for sharing this experience.  It may prove helpful for others considering the option that you chose.  I have seen it recommended numerous times and this proves how real the risk is.

Best of luck to you.

Sorry to hear of the issue for the sake of the OP but glad somebody voiced up in contradiction to the folks who do not see this as a sizable risk.  

DOS enforcement is pretty straight forward as it relates to the servicing of agency loans. (Fannie/Freddie) In this case, either Flagstar is servicing the loans for one of the agencies or they have adopted the same rule as the agencies. Flagstar does both service agency loans and originate loans intended for securitzation. The rule is explicit and simple. A servicer MUST enforce the DOS upon discovering the transfer after a 30 day cure window has expired.

A transfer of ownership of a mortgage held in a security will affect the rating of that security since the secured interest has been impaired.  The borrower who gave the secured interest to the Mortgagee is no longer in control of said property in the same form as when the loan was made.  The new property owner while having to some extent inherited the obligations of the previous owner, enforcing that legal idea in some cases can be tricky and cumbersome.  The transfer creates bankruptcy risk and the previously understood default risk then becomes unknown since the new borrower is not underwritten.  Under those ideas the ratings of the security would be different than they were prior to the transfer.

In the case of an LLC transfer bankruptcy risk is one of the larger concerning ideas. (If it is possible to speculate on such quantification) If the LLC fails and has to file bankruptcy the real property would be subject to the bankruptcy schedule of assets so the property is consider in the bankruptcy which can affect the Mortgagee's collect-ability. Fighting with BK court to make the claim the asset should be exempt not to mention other creditors who would want the asset to be included so they stand a chance of recovery is simply a rat race no Mortgagee in their right mind wants to take one.

Transferring into a revocable living trust will not trigger a DOS enforcement however the property must be primary-owner occupied and the beneficiaries must be the original borrower(s) not a new name beneficiary like a LLC.  So no matter how you slice it or try and circumvent the rule, if you change out the name of the beneficiaries, they can enforce the clause.  Transferring to an LLC is not seen as estate planning or an inheritance event.

I suppose for the sake of the mention, we did just hear rates will not be suppressed by the Fed.  While they did not say they will in fact raise rates, they did say they will raise as necessary and stay as needed, etc.  So in an environment where rates where low and we walk into a market where rates can potentially be higher investors will look to balance their extension risk which is the risk of being invested under prevailing market rates.  That environment will certainly cause more monetary incentives to enforce DOS even on performing loans.    

@Ashley Pimsner yes I am aware the title can be held in a land trust with little recourse from the bank. Its not worth the drama for me. I have found using multiple LLC structures and trusts to hold property to be problematic in scale. To do it right requires much more infrastructure and record keeping than most people will tell you. If you are negligent then it will not matter so much. I continue to carry healthy insurance policies to cover my risk.

@Ned Carey I think it was the insurance notification with the LLC as named insured that drew the red flag. Flagstar and Ocwen prove to be the most difficult to deal with administratively. I plan to just quitclaim the property back to my name and be done with it. I don't have time nor much motivation to start with the Land Trust drama and certainly not looking to "strip" the home. I have credit, assets and relationships that are much more valuable than the home. I'd rather just pay off the loan if it came to that. Here is the actual doc sent to me:

I have other property I have bought and sold subject to financing but don't plan to do anymore such deals. This model has always made me wonder. How do you convince a seller you will keep paying the debt. How is a seller comfortable make a deal relies on a future promise? How is a buyer comfortable that the note will not be called. If it does get called they potentially wouldn't even know about it as the letter would go to the original borrower. This model has never made much sense to me.

Originally posted by @Ashley Pimsner :

@Wally Smythe it can absolutely be done now and hold up. Here is the link to the legal precedent.  

http://www.creonline.com/beat-the-due-on-sale-clau...

https://www.law.cornell.edu/uscode/text/12/1701j-3

If you read the article, it is not guaranteed to protect from a due on sale clause. It is simply a way to help hide the transfer. Here is part of the article:


STEP 4: You are now the beneficiary of the trust. Your trustee makes payments to the lender.

Keep in mind that the assignment of Sammy Seller's interest under the trust to you does trigger the "due on sale," but who is going to tell the lender? In reality, the lender will discover the transfer of an interest in real estate in one of three ways:

  1. Change of name on the deed. Not likely, since lenders don't readily have "spies" at the clerk's and recorder's office;
  2. Different name on the check received for payment. Not likely, since the bank officers are far removed from the clerical workers who process payments; or
  3. Change of hazard insurance beneficiary. This is the most common way a lender discovers a transfer of interest in the borrower's property.

If you notify your insurance carrier of a change in insurance beneficiary, the lender, who is also a named beneficiary, receives a copy of the change.

However, if you transferred title into a land trust, the new beneficiary under the insurance policy will be the trustee of the land trust. The lender will probably not object, since it will assume the seller has implemented an estate planning device.



Read more: http://www.creonline.com/beat-the-due-on-sale-clause.html#ixzz3V9fiWKUe

This will make an impact on many investors' strategies.

Originally posted by @Adam Johnson :

@Ned Carey -     .    .     .       .     the fact is, there is a written contract that has been breached.  When a contract is signed, the terms are what they are and signing means that you agree to live by them. 

My understanding is that there is no actual breach because generally there is nothing in the note saying you cannot transfer the property. The note's "Due on Sale" clause doesn't actually say the note is due upon a sale. It says that the lender has the right to call the note due on sale.

I've heard of banks calling loans when they are transferred to a revocable living trust. I think these might have been apartment buildings of more than four units, for what it's worth, and those properties are not covered by Garn-St. Germain.

My choice of wording may have been poor.  Without knowing how the note was written, it is hard to say whether it was a breach of contract.  I should have been more selective in wording.  Either way, since the lender has called it due or required immediate corrective action, the matter is no less serious.

if you plan on buying the property anyway, can you approach the bank and offer current market rates, but assume the balance?  that way its not tying up your cash.    I mean why else would they call the loan other than it being under market rates?

@Ned Carey

  serge bought this in his personal name so his personal credit is on the line.. and from what I have read about Serge I highly doubt he wants to create a credit issue on his Fico I know I would not.. I would just deed it back to my name as asked and make sure I have proper insurance.. I don't know anything about the land trust stuff but maybe that is an option once you calm the bank down.

I have had one called ( used to buy all my rentals pre 08 sub too here in Oregon)  and the reason it got called was it was a local credit union and the seller went in and told the CU what she did and they immediately called the loan and we simply paid it off

@Serge S.

  I agree with you Sub too in the hands of undercapitalized buyer's is a huge risk to a seller if the seller indeed cares about their credit and or potential of a deficiany judgement

I have had talks before with many banks on this.

Dion has the right track.

"That environment will certainly cause more monetary incentives to enforce DOS even on performing loans."

Over the last 3 to 4 years a lot of local banks were telling me that they were dealing with getting non-performing crud off the books. They were inundated with short sales, loan workouts, and foreclosures so were not looking for DOS violations. Now that they have gotten healthier they have told me they are looking to increase yield and get rid of low yielding loans. As the market starts rising in rates the banks will be motivated to look at each loan under a microscope and try to find any reason to call the loan so they can relend at higher rates.

Money is what makes the world go round whether people like it or not. The trust angles you can say you are using for estate planning etc. and many times they go for it.

This is why I love commercial real estate. When doing loans you do not run into this junk like on the residential side. In fact they expect you to hold in an entity. You still have to try and negotiate away the personal guarantee or get it reduced. If you go CMBS or a low enough LTV you can wipe it out altogether but still have carve outs.

When setting up entities there are multiple decisions for each property that have to be considered. 1. Liability protection 2. Ease of management  3. Tax Angles

They are often rated on a scale from Poor to Excellent. The investor has to decide what level of each and mix is optimal for their situation. 

@DeWayne Mann - the original poster, Serge, purchased/financed the property in his personal name, then quit-claimed it into his LLC for liability protection. In doing so, he violated one of the loan covenants. This may clarify things a little better. Your post seems to be more from the angle of him purchasing a property "subject to" the existing financing, but his particular situation is slightly different.

This problem could result in easier scenario and is, indeed, a very real problem when it comes up and one in which you need to be prepared to act quickly.  If purchasing, you need to be prepared to "buy out" the original lender quickly.  If you were the original borrower and acted as Serge had, then you need to be able to correct what was done.

As @Joel Owens stated, this is why I prefer to use portfolio lenders for all purchases made in the name of one of my LLC's. Portfolio loans, even on 2-4 family property, tend to be made under commercial terms and are therefore easier to work with as a professional investor. Using Fannie/Freddie may seem like a better option because it appears to be "cheaper" money, and it may be, but when you continue to run into walls with their guidelines, cheaper isn't always better.

I was at a closing recently and the lender told me in the past few months he had 3 different banks use the due on sale clause on property transferred to a LLC.

I am speaking to an attorney about drawing up a contract tomorrow for a Subject to purchase. The owners loan is with Flagstar. It's at a 4.6% rate. I wasn't worried about the DOS but after reading this I'm wondering if I should be? My plan was to refinance out in 6 months to one year.

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