Due-on-Sale Clause

A due-on-sale clause is a provision in a mortgage, deed of trust or other security instrument that entitles the lender, at its option, to declare the entire secured balance immediately due and payable if the borrower sells or transfers the property, or an interest in it, without the lender's prior written consent. The federal definition is at 12 U.S.C. 1701j-3(a)(1), a section enacted in 1982 as part of the Garn-St Germain Depository Institutions Act, and the implementing regulation repeats it at 12 CFR 191.2(b).

It helps to place the clause against its parent. An acceleration clause is any note provision that makes the whole balance due before its scheduled maturity; the usual trigger is default. A due-on-sale clause is the species of acceleration clause whose trigger is a transfer of the property rather than a missed payment, which is why a borrower who has never been late can still meet it. Nearly every conventional mortgage contains one, and whether a loan can be taken over by a buyer is the separate question of assumability.

The statute exists because states had gone the other way. Through the 1970s a number of states, by statute or by decisions of their highest courts, restricted a lender's ability to call a loan simply because the property changed hands, usually unless the lender could show its security was impaired. Garn-St Germain reversed that. Section 1701j-3(b)(1) provides that "notwithstanding any provision of the constitution or laws (including the judicial decisions) of any State to the contrary, a lender may, subject to subsection (c), enter into or enforce a contract containing a due-on-sale clause with respect to a real property loan", and (b)(2) makes the exercise of the option "exclusively governed by the terms of the loan contract". Subsection (c) was a transition rule for loans made during those state-law windows; 12 CFR 191.2(p) fixes the window dates in 1982 and the longest transition it allowed ran three years from October 15, 1982. It is history, not a live route.

What counts as a transfer is wider than a sale. The regulation's definition at 12 CFR 191.2(b) treats as a sale or transfer "the conveyance of real property of any right, title or interest therein, whether legal or equitable, whether voluntary or involuntary, by outright sale, deed, installment sale contract, land contract, contract for deed, leasehold interest with a term greater than three years, lease-option contract or any other method of conveyance of real property interests". Two consequences follow that surprise people. A long lease or a lease with a purchase option is a transfer, so renting a house out for five years is within the clause even though nobody has been paid for the house. And an equitable interest counts, which is what puts a contract for deed and a subject-to purchase squarely inside it.

The nine protected transfers, and what they have in common. For a loan secured by residential real property containing fewer than five dwelling units, by a lien on co-op stock, or by a residential manufactured home, 12 U.S.C. 1701j-3(d) says a lender "may not exercise its option" on: a subordinate lien or encumbrance that does not transfer occupancy rights; a purchase-money security interest for household appliances; a transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety; the granting of a leasehold of three years or less without a purchase option; a transfer to a relative resulting from the borrower's death; a transfer where the borrower's spouse or children become an owner; a transfer under a decree of dissolution of marriage, legal separation agreement or incidental property settlement by which the spouse becomes an owner; 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 occupancy rights; and any other transfer described by regulation. Read the list and the pattern is plain: it protects a household rearranging its own affairs and a handful of events that shift no occupancy. None of it is a sale to a buyer, and none of it changes who owes the debt.

The regulation is stricter than the statute, and this is the part most summaries miss. Paragraph 12 CFR 191.5(b) opens by limiting itself: it governs "any loan on the security of a home occupied or to be occupied by the borrower", so everything in it addresses an owner-occupied home. Within that universe, 191.5(b)(1) restates the statutory protections and narrows three of them. The family exceptions at (v) are conditioned on the transferee being "a person who occupies or will occupy the property", a requirement the statutory text does not contain, so a child who inherits a share and rents the house out is outside the regulation's version. The living-trust exception at (vi) requires the borrower to remain "the beneficiary and occupant of the property", and it withdraws the protection where the borrower, as a condition of the transfer, refuses to give the lender "reasonable means acceptable to the lender by which the lender will be assured of timely notice of any subsequent transfer of the beneficial interest or change in occupancy". The subordinate-lien exception at (i) does not apply where the encumbrance was "created pursuant to a contract for deed". And (b)(1) opens by excluding reverse mortgages from the protections altogether.

Three rules run in the borrower's favor, and they are rarely quoted. Under 12 CFR 191.5(b)(2), a lender may not impose a prepayment penalty or equivalent fee when it declares the loan due under a due-on-sale clause or starts foreclosure to enforce one. Under (b)(3), a lender may not impose such a fee where it fails to approve a qualified transferee's completed credit application within 30 days and the borrower then transfers the property to that person and prepays the loan in full within 120 days of the lender's receipt of the application; a qualified transferee is someone who meets the lender's underwriting standards and occupies or will occupy the property. Under (b)(4), if the lender and the buyer agree in writing before the transfer that the buyer will be bound by the loan's terms at a rate the lender requests, the lender waives the clause as to that transfer and "shall release the existing borrower from all obligations under the loan instruments", with the lender treated as having made a new loan to the successor. That paragraph is the formal machinery behind a consented assumption with a release.

Protection can be lost afterwards. Paragraph (b)(5) says nothing in the exception list restricts a lender's right to enforce the clause "upon the subsequent occurrence of any event which disqualifies a transfer for a previously-applicable exception". A home transferred into a living trust while the borrower lived there, and later vacated and rented out, has stopped meeting the regulation's occupancy condition. And under (c), the lender may still require the successor to keep mortgage insurance in place as a condition of assumption.

What the statute encourages, it does not require. Subsection (b)(3) of the statute says a lender "is encouraged to permit an assumption of a real property loan at the existing contract rate or at a rate which is at or below the average between the contract and market rates", and adds that nothing in the section prohibits such an assumption. Encouragement is not a duty, and a lender holding a loan at a below-market rate has an obvious reason to decline.

The sequence is always the same. A transfer occurs, or is proposed. The lender asks whether the transfer is within 12 CFR 191.2(b)'s definition; nearly every conveyance is. It then asks whether one of the exceptions at 12 U.S.C. 1701j-3(d) and 12 CFR 191.5(b)(1) applies, which depends on the property type, the relationship, and under the regulation on who will occupy the home. If no exception applies, the lender may, at its option, declare the balance due. It may instead consent, and if the consent takes the form of the written agreement described in 191.5(b)(4), the original borrower is released and the buyer becomes the borrower.

Consider an example of the 30-day rule at 12 CFR 191.5(b)(3), which is the one place in this regulation where a delay costs the lender money. A homeowner with a $240,000 balance and a note carrying a 2 percent prepayment penalty finds a buyer who will occupy the house and who meets the lender's underwriting standards. The buyer submits a completed credit application, and the lender receives it on March 3. The lender does not approve it within 30 days, so by April 2 the condition in (b)(3) is met. The homeowner then transfers the property to that buyer and pays the loan off in full on June 20, which is inside the 120-day window running from March 3. The prepayment penalty that would otherwise apply, 2 percent of $240,000, or $4,800, may not be imposed.

Change one fact and the result changes. If the buyer intends to rent the house out rather than live in it, the buyer is not a "qualified transferee" as 191.5(b)(3) defines the term, the 30-day clock never starts, and the penalty stands. The occupancy condition does a great deal of work throughout this regulation, and it is the condition a reader of the statute alone would never see.

Pros

• The protected-transfer list keeps a lender from calling a loan on the events a family cannot control, including death, divorce and a spouse or child becoming an owner.
• The living-trust exception makes ordinary estate planning possible on a mortgaged home without asking the lender's permission.
• A borrower can rent the property out under a lease of three years or less without a purchase option and stay inside the protection.
• The regulation bars a prepayment penalty when the lender is the one invoking the clause, so a borrower forced to pay off early is not charged for it.
• A written waiver under 12 CFR 191.5(b)(4) releases the original borrower outright, which is a cleaner outcome than an informal arrangement.

Cons

• The definition of a transfer is wide enough to catch conveyances that feel nothing like a sale, including a five-year lease, a lease-option and a contract for deed.
• None of the nine exceptions helps a borrower who wants to sell, which is the transfer people actually plan.
• The regulation's occupancy conditions are invisible to anyone reading only the statute, and they decide real cases.
• Protection is not permanent: a later change in occupancy or beneficial interest can re-arm the clause on a transfer that was protected when it happened.
• The lender's consent is discretionary. A lender holding a below-market loan has every reason to refuse, and the statute only encourages assumption.