What is the Due-on-Sale Clause?

Before we discuss how to get around the due-on-sale, we must understand what it is and where it came from. The due-on-sale is a clause in a mortgage document which gives the lender the right to demand payment of the remaining balance of the loan when the property is sold. It is a contractual right, not a law. This means that if title is transferred, the bank may or may not decide to "call the loan due." You don't get arrested for violating the due-on-sale.

Where Did the Due-on-Sale Dilemma Come From?

Banks began inserting due-on-sale clauses in their mortgages in the '70s when interest rates rose dramatically. Home buyers were assuming existing loans rather than borrowing new money from banks because the interest rates on existing loans were lower. The banks used the due-on-sale as a way to kill their own worst competition.

The homeowners fought the banks in court claiming that the enforcement of the due-on-sale was "unfair trade practice." The consumers won, but the banks lobbied Congress to pass a federal law which would supercede the courts. The banks ultimately won and the "Garn-St. Germain Federal Depositary Institutions Act" was passed.

The Garn law gives the banks the right to enforce the due-on-sale, but it also carves a few exceptions in which the lender may not enforce it. One of those exceptions is that a homeowner may transfer title to a living trust for his own benefit.

Enter the "Land Trust"

The land trust is form of a revocable, living trust (you may have heard of these "living" trusts promoted by estate planning professionals). A land trust, like a living trust, is create by two legal documents:

1) A trust agreement between the creator (called "grantor" in legal terms) of the trust and the trustee which defines the trust arrangement; and

2) A deed from the creator of the trust to the trustee.

The trustee holds title for the benefit of the grantor (in this case, the grantor is also the "beneficiary"). If you place title to your property into a land trust, you have not violated the due-on-sale.

Let's say that you come across a seller who is willing to give you title to his property for almost nothing down. The only glitch is that the loan is not assumable because the mortgage has a due-on-sale clause. Here's the process for getting around it:

STEP 1: Sammy Seller signs a trust agreement with a trustee of YOUR choosing (e.g., your brother-in-law, partner, attorney, etc.) Sammy is named as the "beneficiary" of the trust.

STEP 2: Sammy Seller transfers title to the trustee (no violation of the due-on-sale clause)

STEP 3: Sammy Sammy writes a letter to the bank which reads:

"Dear Mr. Lender:My attorney has advised me to transfer title to my property into a revocable, living trust for estate planning purposes. You will receive all future payments from the trustee named below"

signed, Sammy Seller"

STEP 4: Sammy Seller quietly assigns his interest under the trust to you (similar to a transfer of stock in a corporation). This assignment is not recorded in any public record.

STEP 5: You are now the beneficiary of the trust. Your trustee makes payments to the lender.

Keep in mind that the assignment of Sammy's Seller interest under the trust to you IS a violation of 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 named beneficiary under the insurance policy will most likely be the trustee of the land trust. If you then sell the property by transferring the beneficial interest in the trust, the lender will not be notified since the insurance beneficiary (the trustee) has not changed.

You now have a safe, easy strategy to get around the due-on-sale clause. Let's not hear another word about it!

William Bronchick, J.D. is an author and attorney who regularly presents workshops and do-it-yourself seminars at real estate and landlord associations around the country. He is the president and confounder of the Colorado Association of Real Estate Investors. Bill specializes in all forms of asset protection and is the author of several great home study courses, including:

* Flipping Properties
* How To Create a Real Estate Cash Cow
* ABC's Of Asset Protection Course
* Your Step-By-Step Guide To Land Trusts
* How To Create A Bulletproof Corporation
* How To Form Your Own Limited Liability Companies
* Lease Options Workshop
* Nuts & Bolts of Creative Real Estate Transactions

Bill Bronchick is also the host of our Legal Corner.