Due on Sale Clause Guide

As you likely already know, offering the option of seller financing can be an effective way to make purchasing your home an option for a greater variety of buyers. However, you may not be aware that, if you have an existing home loan, the process will become a little trickier, mainly due to the due-on-sale clause in your mortgage.

Read on below to learn more about what this clause is, how it works, and how you can protect yourself while still getting the chance to offer seller financing to the buyer of your choice.

Key takeaways

By the end of this article, you will know that:

1. A due on sale clause in a sale contract puts parties on notice that the seller of a property has to pay the balance of their mortgage in full if they transfer the deed to another owner.
2. You can use a wraparound mortgage to overcome the problem created by a due on sale clause, but it comes with risks.
3. These risks can be reduced by properly structuring the terms of sale and the new mortgage.

Let’s start with the basics: what is a mortgage clause? Put simply, a mortgage clause is a provision in your loan that is meant to protect the lender. In particular, the due-on-sale clause in real estate loans allows the lender to demand that the loan be paid in full when the deed is transferred. 

What is a due on sale clause?

A due on sale clause definition can be summed up fairly easily: It’s a provision in most mortgages that states the loan must be paid in full upon the sale or transfer of ownership of the property. Also sometimes referred to as an “acceleration clause” or a “wrap-around mortgage due on sale clause,” this provision means that the loan will not be assumable and that the seller of the property will typically need to use the proceeds from the sale of their home to pay off the loan.

Ultimately, lenders prefer when a loan is due on sale because it protects them from having the loan transferred to a new owner when the rate on the loan is below current market rates. In general, holders of a mortgage with a below-market rate — or secondary mortgage market products that are backed by below-market-rate loans — tend to prefer that the loan be retired early.

Exceptions to the due on sale clause

Notably, there are a few due on sale clause exceptions. These include:

• Transfer where the spouse or children of the borrower become an owner: If a property is transferred to a spouse or children of the borrower, the mortgage can usually be assumed without triggering the due on sale clause. This type of transfer might occur while the borrower is still alive, possibly for estate planning or familial support reasons.
• Leaseholds under a certain duration: In some cases, if the homeowner decides to lease out the property, as long as the lease is for less than a specific period (often three years) and does not contain an option to purchase, the due on sale clause may not be activated. 
• Transfer to an ex-spouse as part of divorce proceedings: Similar to transfers resulting from divorce or separation agreements, if a property is explicitly transferred to an ex-spouse as part of finalized divorce proceedings, the due on sale clause typically doesn’t apply.
• Joint tenancy situations: When a joint tenant is added or changed on the title, particularly when this involves a spouse or direct family member, this might not trigger the due on sale clause. This can facilitate estate planning or changes in ownership between family members without the need to refinance.
• Modification of ownership among co-owners: Changing the proportion of ownership among co-owners of the property, without changing the parties in ownership, might not trigger the clause. This can be common in scenarios involving investment properties or family-owned homes where ownership percentages are shifted.
• Transfer to a relative after the borrower’s death: When a property owner dies, the mortgage can be transferred to a relative without triggering the due on sale clause. This allows the relative to take over the mortgage under the same terms.
• Transfers between spouses or children: The loan can often be assumed by a spouse or child without having to pay it off immediately. This is common during a divorce or as a part of estate planning.
• Transfers into a living trust: If a homeowner decides to place the property into a living trust for estate planning purposes, this generally does not activate the due on sale clause.
• Transfers resulting from divorce or separation agreements: When a property is transferred to a spouse or former spouse as part of a divorce decree or separation agreement, the lender typically cannot enforce the due on sale clause.

Unfortunately, these exceptions are not applicable to owner financing.

Due on sale clause example

Before we get any further into the methods you can use to work around a due on sale clause in your loan, it might be useful to take a closer look at a due on sale clause example so that you have a better idea of what to expect from this provision.

For the purposes of this example, let’s say that Sally originally took out a $300,000 loan when she bought her home. Let’s say, after a few years of paying down hrt mortgage, Sally decides to sell her home even though she still has a $150,000 loan balance left. Fortunately, after being on the market for a little while, Sally gets a $325,0000 offer on the home.

At closing, the due on sale clause in Sally’s original mortgage comes into play. In order to transfer the deed to the property to the new buyer, Sally must first pay off her remaining loan balance. So she uses $150,000 of the proceeds from the sale of the home to satisfy her debt to his lender, which leaves her with a total of $175,000 in profit.

The risks of trying to dodge a due on sale clause with a wraparound mortgage

Many buyers will try to circumvent due on sale clause by offering up the possibility of a wrap around mortgage. A wrap around mortgage is essentially a junior loan that encompasses the cost of the existing loan, plus the cost of any equity in the property. With one of these loans, the buyer is responsible for making a regular installment payment to the seller. The seller, in turn, is responsible for using a portion of that payment to pay down the original mortgage loan.

In some cases, the deed of trust will be signed over to the buyer. When that happens, a lien will be placed on it for the amount of the existing mortgage loan, plus any additional amount that the new buyer owes to the seller. Traditionally, the wrap mortgage will have a higher interest rate than the primary home loan so that the seller will be able to make a small profit in exchange for the trouble.

A wraparound mortgage more or less allows the seller and the borrower to get around the due on sale clause because, as long as the primary home loan is still being paid in a timely manner, the lender is unlikely to enforce the due on sale clause. However, agreeing to this wrap mortgage due on sale clause workaround is also inherently risky.

For one, if the buyer stops making payments toward the wraparound mortgage, the seller will still be responsible for making their payments on the original loan. For another, if the lender finds out about the transfer of the deed, they could ultimately exercise their right to the due on sale clause and then the loan would need to be repaid in full.

How having a due on sale clause in an existing mortgage affects the creation of a private mortgage note

In order to avoid having to pay the mortgage balance in full, some sellers simply do not inform their mortgage company that they will be entering into an owner financing arrangement. After all, the lender will have very little reason to invoke the mortgage due on sale clause if the loan is paid in a timely manner, as would be the case if you entered into a successful wraparound mortgage.

However, knowing the risks, you’ll have some additional considerations when putting together your private mortgage note. You’ll either want to construct the note so that it has a large enough down payment to pay off your existing loan or ensure that the deed to the property will not be transferred to the new buyer until such time as you are able to pay the loan off in full.

Once created, you could also sell your mortgage note to a note buyer like Amerinote Xchange. Loans that contain due on sale clauses are generally considered preferable when selling a mortgage note. However, they are not always necessary. For example, they are usually seen in longer-term loans, where the loan is paid off in decades. They are not as common in short-term loans, such as fix-and-flip loans.

The Bottom Line

If you have an existing loan on your home, the due on sale clause makes offering owner financing on your home riskier than if you owned it outright. However, by making sure to structure your mortgage note carefully and by considering selling your note to a qualified buyer, you can protect yourself from the possibility that your lender will one day call your entire loan due. Together, these options will allow you to safely and confidently offer seller financing for the sale of your home.

Frequently Asked Questions

Can I still sell my home if it has a due-on-sale clause?

Yes, it’s still possible to sell your home if it has a due-on-sale clause, but it will require the permission of your lender. You can do this by requesting that your lender release you from the due-on-sale clause in your loan.

Do VA loans have a due on sale clause?  

Yes, VA loans typically include a due on sale clause. This clause is activated if the property is sold, requiring the full repayment of the outstanding loan balance at the time of sale.

Do all mortgages have a due on sale clause?  

Most mortgages do include a due on sale clause, especially those originated by banks and mortgage companies. This clause protects the lender by allowing them to demand full repayment of the loan if the property is transferred to a new owner.

Can my lender enforce the due on sale clause if I make my mortgage payments on time?  

Yes, a lender can enforce the due on sale clause regardless of whether the mortgage payments are made on time. This clause is triggered by the transfer of property ownership, not by payment delinquency.

Is a due on sale clause a lien?  

No, a due on sale clause is not a lien. It’s a contractual provision in your mortgage agreement that requires the loan to be paid in full if you transfer the property. A lien, on the other hand, is a legal right or interest that a lender holds against property until the debt associated with it is paid off.

Can the borrower stop the lender from enforcing the due on sale clause?  

Generally, it is difficult for a borrower to stop a lender from enforcing a due on sale clause if the lender chooses to exercise this right. However, communication with the lender about your intentions and seeking a formal assumption of the loan by the new buyer could be potential ways to negotiate.

What are my options if I can’t pay off the mortgage after selling?  

If you can’t pay off the mortgage after selling the property, you might consider arranging for the buyer to formally assume the mortgage, if your lender and loan type allow. Another option could be to negotiate a short sale with your lender if the proceeds from the sale won’t cover the mortgage.

Can an assumption clause override a due on sale clause?  

An assumption clause does not necessarily override a due on sale clause. Instead, it provides a process by which a new buyer might be allowed to assume the existing mortgage under the terms set out by the lender. The lender’s approval is usually required, and not all loans or lenders permit assumptions.

Does a due on sale clause affect refinancing?  

No, a due on sale clause does not affect refinancing. Refinancing is a process where you replace your current mortgage with a new one, typically with different terms, which is still in your name. Since the property is not being transferred to a new owner, the due on sale clause is not triggered by refinancing.

How can I tell if my home or property is eligible for seller financing?

Your real estate must be free and clear of any existing mortgages or liens in order to qualify for seller financing. If not, you may need to consider a wraparound loan. Additionally, you will need to provide a loan agreement that outlines the terms of the sale, including the interest rate, repayment schedule, and other important details.

Where do I begin with seller financing?

If you’re interested in seller financing, a good place to begin is to contact a real estate attorney to draw up the necessary paperwork. You’ll also need to work with a loan officer or mortgage broker to get a pre-approval for a loan. Once all these elements are in place, you can advertise your property as a seller-financed home.