Due On Sale Clause: Myth or Fact?
Investor · Colorado Springs , CO · Member since 2013 · 77 posts · 22 votes
IMHO, if you're going to buy subject to (which I do not) this is NOT the correct strategy. If you're buying subject to you should be prepared to deal with a loan call by paying off the loan. Period. Refinance, get private or hard money, leverage another property, something. As far as the seller's concerned they've sold you the house. Now you say "sorry, I need to return this house." That would be devastating to many sellers. You bought it. In buying subject to you assume the risk of getting the loan called. Its your responsibility, IMHO, to mitigate that risk if it happens. If you're unwilling or unable to deal with that risk, don't buy subject to.
Bryan, it's been written. It's not a myth, the length of time you hold is probably the biggest factor. Search here on BP, I have given break downs as to the approx.% with several as I had a servicing company for installments. :)
Hey @Bryan Rodriguez I'm definitely not the pro on this, but from what I've read and heard, it's usually not a major issue YET but there is a lot of speculation that once interest rates rise - the banks might start caring more and force people to refinance into higher rates.
Afterall, if you are paying just 3%, and they can get 15% investing that money elsewhere, they make just force your hand to do pay them off- putting you in a bad position. For this reason, I don't mess with them. But there are some really successful investors who do invest this way, like @Karen Rittenhouse - so maybe I'm just too pessimistic! And speaking of Karen - definitely listen to the Podcast we did with her, as it covers this stuff well.
@Steve Babiak is or expert linker, he can find anything here! Sorry, 12,000+posts and I'm lost at finding them, but I'd say if you entered "Avoid Due on sale" it will be there, it wasn't initially my post.
Banks have written loan policies they must follow, large one like BoA will call it, they don't care if it's performing, depends on the mood of the days it seems, but larger banks tend to lower the hammer. Didn't follow you last question, a seller can't assign the note.
Take note of the SAFE Act issues with installments deals, it's more of an issue than the DOS, but it is an issue. :)
Hi Bryan:
As @Brandon Turner mentioned, we used subject-to successfully for years purchasing well over 100 properties this way. Hold properties, no less.
We've still never had a bank call one due. The Due on Sale Clause gives lenders the "right", not the "obligation" to call the note.
We have had 2 credit unions threaten to call, but after much discussion, were convinced to let us keep them. We've even called banks on several different deals to see if we could get the loan transferred to our own name, only to have them tell us to simply keep it like it is and continue paying according to the existing terms.
And, we've received letters saying basically, "We see the name on the deed and insurance policy have changed so we're not really sure what's going on with this property, but please continue to send the payments as directed to....."
I say all this to point out that, in general, it appears most lenders are happy with performing assets.
At least this has been the case for the past 10 years in a declining economy. Again, as Brandon pointed out, we have no idea if this attitude will continue. In fact, we've stopped buying this way unless we're planning to renovate and flip the property. No longer doing it for holds. Plus (and this is a big one) our state attorney general (North Carolina) HATES subject-to purchases -- a few bad apples spoiling it for the rest of us.
At this point, we also believe banks may be quicker to call loans with low interest rates as rates continue to climb. Unless you are able to refinance, as you suggested, or pay off the loan with private money, etc. as needed, you are taking a risk.
Know that and stay prepared.
Thanks for asking and please keep us posted as to what you find going forward.
Here's wishing you tremendous real estate investing success!
About a year ago I attended a seminar put on by some local folks. One of the sessions was on subject to deals (which is all these AMPS deals are.) There was a lot of discussion during the session and at one point someone asked for a show of hand of folks who had a mortgage called due or knew someone who had. Of about 300 people a handful of hands went up. So, while its rare, it does happen.
If it does, what happens. The lender sends someone a letter saying the mortgage is being called. If it doesn't get paid off, they start a foreclosure. The timeline is state dependent.
I think the real risk is interest rate dependent. As long as rates are low calls will be rare. If rates go up, they will increase.
In addition, if a Lender does call the note then can the Buyer just refinance with a WRAP Mortgage?
Bryan, the Due on Sale clause or Alienation Clause came about as a result of exactly what Brandon Turner described in the 1970's and early 1980's. In 1982 congress created the Garn–St. Germain Depository Institutions Act which made the DOS a federal enforcement issue. The clause is enforceable and was used back then. I would say, history is your example of what if's. Since the roll out of Garn, rates have been falling so you will not have a bunch of examples of the clause being used. I can also tell you, I have personally used the clause in a couple of some notes, accelerating and calling due. It is not a myth. It is and always be an option to the mortgagee to use where the law allows and will be used where it benefits the mortgagee's interests in general not just with rate.
If the Mortgagee calls the note due, then paying the Mortgagee satisfies the demand. Can that be done with with a Wrap? NO. A Wrap usually refers to wrapping the existing mortgage with a new mortgage with enough interest and principal so as to allow debt service from that note to pay for the existing note that was wrapped. A wrap does not usually involve payment in full of the underlying mortgage obligation.
Essentially all a Wrap does is create a payment arrangement with a secured interest inferior to the present mortgage. The mortgage that was called due is the superior mortgage and if the mortgagee demanded payment in full then paying less than entire balance does not satisfy the demand. Or another way to say it, a Wrap is not a refinance which 'replaces' existing mortgage debt, it only goes on top. So, a wrap would not satisfy a payment in full.
In the event the DOS is triggered and the note balance is accelerated and called due, the mortgagor (borrower) has time to pay in full and failure to pay in full leaves the mortgagee with the ability to pursue foreclosure per the state where the subject property is located. During said foreclosure process, or anytime, prior to the expiration of any foreclosure action including any redemption period, paying the full balance of what is due, always satisfies the debt, since that is all that was due.
Bryan, just so you know, AMP is not a real term, just some gurus "repackaging" of Sub2. While the risks of the DOS is small, your thought that a wrap could somehow pay off the loan being due, shows a basic lack of understanding of the basics of RE. Not trying to be rude, but this is where a little bit of knowledge can get you and some buyers/sellers in a lot of trouble.
Can you tell us the risks to the buyer and the seller in a sub2 deal, other than the DOS, and how to mitigate them? Are you trying to resell to an end buyer with "seller financing"?
Can you tell us the risks to the buyer and the seller in a sub2 deal, other than the DOS, and how to mitigate them? Are you trying to resell to an end buyer with "seller financing"?
Pretty hard for one or the other to mitigate risks on the other side, that's why there is more risk involved.
I certainly hope there is not some guru thing passing seller financing off to a new buyer with an assumption of debt! :)
I certainly hope there is not some guru thing passing seller financing off to a new buyer with an assumption of debt! :)
Bill's quoted text^^^
@Bill Gulley that's exactly what it is. This "system" originally went by a different name that make it sound like the mortgage was being assumed by the new buyer. It was later changed to the current name, which, if nothing else, is a little clearer about what's actually happening. In addition to buying subject to, this system has the property being resold to an end buyer. A very dangerous process, if you ask me.
No, no, no.
Never re-sell a subject-to with seller financing. First, because there is an obligation to the seller you purchased the property from and secondly, it is now a law here in North Carolina that in order to sell with owner financing, you must be on both the deed and the mortgage.
One hole in the system our state government managed to plug.
Thanks for those important comments, @Wayne Brooks and @Jon Holdman.
You know, I'm amazed really, you can't write a book about how to put insurance together or split options of stock or give advice without the proper license in insurance or securities, especially illegal advice.
Such books that are written on insurance plans and securities are written, but the author is certainly vetted by credentials at least by those who buy them and they are by respected publishers like P-H or Black's or even Barron's.
If they can pass stuff like the SAFE Act, limiting trade in property right's I'm not seeing why RE Commissions can't crack down on giving RE investment advice, I'm not talking about REI clubs or forums where we chat, but in mass distribution of investment strategies.
These gurus are nothing less than a danger to the public economic welfare.
What is just as bad, is that people are so desperate that they do absolutely no investigation of RE gurus and take, hook line and sinker, whatever drools from the pages or mouths of these con artists. These same people would probably never try to do "puts & calls against the box" in securities with little funds, yet they get involved in attempting to pull off some RE deal in the tens of thousands of dollars with absolutely no or very little knowledge of RE!
Just seems to me that there should be some way to put these gurus in jail.
Rant is over :)
Devising some seller financed deal, especially in these current times, that is made so as to allow an assumption of the debt without consent is a pretty good foundation to build a fraud case on, especially from someone who is totally unaware of the implications. Run from this, don't just walk away. :)
Children playing with Uzi's.
First and foremost, thank you to everyone who replied, especially, @Brandon Turner and @Karen Rittenhouse . Mrs. Rittenhouse, the Podcast was amazing and your website is very informative. Congratulations on your success! Hopefully, my wife and I can be just as successful.
From my understanding, it appears a strategy, which is essentially utilized to provide financial freedom to a homeowner, who is on the verge of credit turmoil, is only acceptable in the lender's eyes, during times not lucrative for them. I ask myself, minus the assumable loans, where is the enforcer, who enforces the standard for every lender. If there is a right, then one should enforce it, because it was set for a legitimate reason.
Based off the guidance, "Its better to asks for forgiveness, than to ask for approval." Find the right attorney that is comfortable in defending the strategy. Negotiate and legitimize with lenders on the importance of maintaing a performing asset. Be prepared for the worst, by ensuring the seller is able to receive the title back and save the asset.
I definitely will take a more cautious approach in entering this strategy. Just like Mrs. Rittenhouse mentioned, "In fact, we've stopped buying this way unless we're planning to renovate and flip the property. No longer doing it for holds", seems to be the most effective application, because you will be able to quickly pay off the mortgage after the sale, migitaging the risk due on sale caluse.
P.S. BiggerPockets is THE BOMB. Ideas: BiggerPockets needs to come out with a quarterly or monthly magazine. BP needs to open up a consulting firms. BP needs to conduct an international edition (i.e Europe).
IMHO, if you're going to buy subject to (which I do not) this is NOT the correct strategy. If you're buying subject to you should be prepared to deal with a loan call by paying off the loan. Period. Refinance, get private or hard money, leverage another property, something. As far as the seller's concerned they've sold you the house. Now you say "sorry, I need to return this house." That would be devastating to many sellers. You bought it. In buying subject to you assume the risk of getting the loan called. Its your responsibility, IMHO, to mitigate that risk if it happens. If you're unwilling or unable to deal with that risk, don't buy subject to.
This thread took on a more conservative thread I feel than past threads. Many past threads will say how this isn't a risk etc. Personally, I don't think my loans will get called by a transfer into LLC (mainly due to servicer/securitization of MBS). However, I also want to mitigate that risk to extent I can. Research says I cannot eliminate the risk. What I will do is put properties into land trust and name LLC as beneficiary. Beneficiary transaction is not publicly recorded. If a bank asks, will show theem land trust creation. if they ask to see beneficiary of trust, i can put properties out of LLC again into my own name. However, I'm NOW being told that transfer into a trust for an investment property isn't count as avoiding the due on sale clause. Blast!
Everything Jon said is right on. Not sure if you realize this but just because you deed back to seller doesn't mean the lender can't continue with the foreclosure based on the transfer to you, a violation of the due-on-sale clause in the note, a contractual breach between the lender and the borrower. The trigger was pulled and it can't be un-pulled, even by deeding back, except at lenders option.
Totally agree Jon.
Who regulates these? First, the CFPB is the new cop on the beat, HUD can, in fact, depending on where the trail leads, the mail being used, false communications with banks, lack of due diligence, wrongful collections along with other possibilities, there is an alphabet soup of federal and state agencies that you could be talking to. They don't give approvals. Nor due they forgive easily without some skin.
You can plan all you like, things can. do and will happen. People get divorced, they lose jobs, get arrested and go to jail, they take bankruptcy, they get sick or injured, they go into nursing homes and people die, all can present problems that bring such deals to the surface. Some family member finds out mom sold the farm and they call an attorney. People go to attorneys and set up estate plans, then that attorney sticks a nose in the deal. People get sued and there are asset inquiries. People don't pay taxes and the IRS wants a few facts. Properties get damaged and insurance claims are made, the bank wants to know who you are.
For those who have done installments or sub-2s, maybe they have done 200 over the years, they can get lucky, they can have an issue and it could still be worked out, in years past we weren't dealing with the issues we are now. Over the years we serviced over a couple thousand installments, one big exit we had was that, which others don't have, was the ability to refinance them, in the market or privately. We probably heard the threat of the due on sale 500 times. Many, most slack off because the deal was being serviced much the same was as if a second mortgage had been made. Can you say you're a registered lender doing servicing? Can you give guarantees to advance payments even if a payment is not made as agreed and show funds in reserve? It's much different when you have servicing involved and ABC Mortgage Company. We still had several we ended up paying off to save the day. What are you going to tell a bank, that you're on your 10th property deal, you are a member on BP and you have read all the guru books? That you will step up and make a payment.....Really.... Just saying your ability to make it happen, your track record, demonstrated knowledge, assets and professional approach will have much to with a bank saying pay up now.
Years ago I had regional bank officers call and ask if we had a servicing contract, I'd tell them, the loan officer would say "oh, okay Bill, just keep me informed" or something similar, or "Bill, are you doing this deal?", okay!. Things were totally different just 6 years ago.
Ask those that do these how many times they had these life events mess up a deal, maybe 2, 8, 14 times in 15 years, I'm guessing I've been through it over a hundred times, where something occurred to someone connected to a deal. It's all about the numbers and pure luck.
As I have said before, many times, you can do 50 deals and never have an issue or you could blow up on your second deal. You have no control nor can you know when some event will happen. You need to be able to take these deals out, or don't do them. I'm not saying you need a million bucks, I'm saying you need to do extreme due diligence and have options available to take out a deal if you need to. It's not just understanding how a Dub-2 works, it's understanding all the ramifications and what ifs that you need to be aware of too. Walking away is not an option! Especially with the compliance issues floating about today. Frankly, I would not do these for a short term like 90 days, (or longer) there are other ways to skin the cat in the short term without going there. Asking forgiveness could be asking your cellie to forgive you for dropping his soap. :)
Let me rephrase. The DOS will not be an option for a lender if you can show that the transfer is directly connected to an estate planning strategy, it is one of the exceptions in the Act.
Still may not get you past financing or servicing issues. :)
@bill gulley
Here is what one person told me regarding the DOS for trust/investment property -- I have't received the Garns Act myself:
"technically, under the Garns Act, a transer into a trust is exempt from DOS only if the borrower is an occupant of the property"
Bill, out of curiosity ,do you have an paragraph summary explaining why the current world where loans are 'sold' to banks may reduce odds of getting hit with DOS? i.e., how does one tell if their own loan has been securitized, or is merely being serviced by Chase vs. owned outright by chase?
You may find this interesting reading: Preemption of due-on-sale prohibitions. The one related to trusts says:
As soon as you change the beneficiary you've violated the clause.
The real kicker is insurance. You'll want insurance that will pay you in the event of a loss. The lender wants to be named on the policy. If you get a new policy in your name and put the lenders name on it, they're going to see your name. If you leave the seller's policy in place you have zero chance of ever collecting on a claim from a policy that's not in your name. For that matter, I'm trying to get a claim done right now and I'd say you'll have a tough time collecting on an insurance claim from a sub 2 deal period if your name and the lenders name are on the policy. Checks from the insurance company will be made out to you and the lender and the lender will have to endorse them before you can use them. That means calling or talking to the lender to get them to endorse the check. They're probably not even going to talk to you if you're not on the account. So, better just plan on buying one policy in the name of the seller and the lender and a second policy in your name without the lender. If you have a claim, you'll make it against the second policy. IDK. Maybe with a power of attorney you could thread this needle and get the lender to endorse the check even if you're not on the policy. But rest assured they will know what's going on at that point.
@ all
This thread is great! Exactly why I began absorbing like a sponge from BP! Thank you all!
You may find this interesting reading: Preemption of due-on-sale prohibitions. The one related to trusts says:
As soon as you change the beneficiary you've violated the clause.
Yup, on the beneficiary angle, you are correct. Use of trust does disguise the transfer however as naming the beneficiary is not a public document. If bank wants to see that you are owner you can put your name back as beneficiary.
The latter part on "occupancy" is what I guess my latest attorney was referring to, in terms of perhaps not holding true for investment property?
But, if you lie about the beneficiary, it's fraud, bye bye!
There is no real issue ast o notes sold, it's generally about how astute the servicer is, not the ultimate holder of the note.
Any transfer accomplished for estate planning reasons will be exempt, it doesn't need to be a living trust. :)
BTW, if you're desperate you could marry an old investor, get a divorce 60 days later and deed it to them, that avoids the DOS as well. :)
@Bryan Rodriguez It's not a question of whether or not a lender CAN act when the due on sale clause has been violated, it's a question of IF they will act. I've watched this thread for a while and stayed out of it until now, but it is a common business practice of many investors to do wraps. Wraps aren't illegal as some may claim, but they do break loan covenants...particularly the due on sale clause that virtually every mortgage/deed of trust will contain. It usually does trigger the default provisions within the mortgage and, as a result, a lender that is paying attention may be able to raise the rate to the default rate, usually the lesser of 18% or the maximum allowable by law, while they foreclose. The idea is that most banks/lenders, like the government, are huge bureaucracies. They don't pay attention to a loan until something happens that gets their attention, such as the loan payments quit coming in, the taxes aren't paid, or the insurance is cancelled. The lending/servicer staff members that usually watch this stuff are usually clerical in nature, underpaid, and really don't care. The higher ups might care, but they aren't the ones watching tens of thousands of loans. If the loan is sold off to a smaller, more nimble group like us, we're going to pay more attention, probably catch it, and we'll act. Many private groups, just like a real estate investor would, will see the opportunity to get the property back as a reason to act. The bottom line is that it is not illegal to do a wrap, but it does violate the terms of the mortgage/deed of trust and the lender can act accordingly. If they are interested in cash flows, the new payor is a stronger payor than the old payor, and the interest they are receiving is right, they may choose to ignore the breaking of the loan covenants. If, however, interest rates change or they feel they can make more money by foreclosing, then you may see the loan thrown into a default status. Grab a standard mortgage or deed of trust and read it. Pay close attention to the due on sale clause, default provisions, and the default rate and then take another look at this question armed with that knowledge. Ask yourself, 1) will the lender notice or care if a wrap is done and 2) am I willing to accept the risk. I hope this helps. In our case as note holders, we're probably going to throw the note into default, collect as much interest as legally/contractually possible, and move to get the property back if the note is upside down. Keep in mind, in the case of a mortgage that is upside down, we probably paid a lot less for the loan than what the property is worth.