Housing Counsel: The "Due on Sale" Concept

Written by Posted On Sunday, 13 November 2005 16:00

Question: My mother owns a home, which was titled in her name because of our current financial situation. My husband, our three children and I live in the home, and since the house was purchased three years ago, we have made all of the mortgage payments, and have kept it in good shape.

We would like to have the house transferred to us, but our credit situation is still negative. Bad. Can the property be transferred into our names, and we will just assume my mother's mortgage obligations? Someone has advised us that a lender can use the "due on sale" clause in the mortgage documents and block this transaction. Can this happen?

Answer: The short answer is no. Federal law permits certain real estate transfers even though the loan documents contain the "due on sale" clause.

Let's look at this concept. Three years ago, when mortgage interest rates were very low, your mother purchased the property and obtained a mortgage with a 5 percent interest. Now, rates are slightly higher, although with your credit situation, you may have to pay a much higher rate because you are a potential credit risk. Mortgage lenders are in the business of making money, and obviously they do not like to allow people to assume a low interest rate when rates are much higher.

This scenario sounds unlikely in today's market place, but many readers will recall the excessively high mortgage interest rates during the past decade.

Thus, many years ago, the mortgage industry came up with the concept of "due on sale." Most mortgage loan documents contain language to the effect that if property which is secured by a mortgage is sold or transferred without the lender's prior written consent, the lender has the right to call the entire mortgage due, and insist on payment in full. This is known as the "due on sale" clause.

There has been much litigation over this concept throughout the country, and the great majority of the Court cases have upheld the lender's right to enforce the due on sale concept.

In l982, however, Congress enacted the Garn-St. Germain Act (12 UCA 1701j-3), which imposed certain restrictions on the enforcement of this clause.

This law contained 9 specific exemptions where a lender was not permitted to exercise its option pursuant to a due on sale clause. When there is a real property loan secured by a lien on residential real property containing less than five dwelling units -- including a lien on the stock of a cooperative housing corporation -- a lender could not enforce the due on sale clause under the following circumstances:

  • a transfer where the spouse or children of the borrower become an owner of the property;

  • a transfer to a relative resulting from the death of a borrower;

  • a transfer by operation of law on the death of a joint tenant or tenant by the entirety;

  • a transfer resulting from a decree of a dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement, by which the spouse of the borrower becomes an owner of the property;

  • 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 rights of occupancy in the property (i.e. the so-called "Living Trust");

  • the creation of a purchase money security interest for household appliances (i.e. where you pledge your house in order to purchase a refrigerator);

  • the granting of a leasehold interest of three years or less not containing an option to purchase;

  • a subordinate lien which does not involve a transfer of rights of occupancy in the property, and

  • any other transfer or disposition described in regulations prescribed by the Federal Home Loan Bank Board.

I highlighted your situation by listing it first on the list. Clearly, you would fall under the category of a transfer where the children of the borrower become an owner of the property.

However, here are some suggestions before you proceed to transfer the property into your name:

First, do you really want to do this? Have you considered the tax implications of the transfer. Let's look at this example: your mother purchased the house three years ago for $200,000 and it is now worth $300,000. On the transfer of the property, your tax basis will be your mother's basis. The law is very clear that when there is a gift of property, the basis of the grantor becomes the basis of the grantee. Should you ever want to sell the property -- and depending on the tax laws in existence at that time -- you may have to pay a large capital gains tax. Under current laws, if you and your husband file a joint tax return, you can exempt up to $500,000 profit, if you have owned and used the property for two out of the last 5 years prior to the sale. However, there is no guarantee that this law will stay on the books and you should discuss your plans with your tax advisor.

Second, there will be some costs involved in this transfer. Generally, a transfer between parent and child is exempt from State transfer and recordation tax. But you will have to pay someone (usually an attorney licensed to practice law in the jurisdiction where your property is located) to prepare and record the deed. And there will be a nominal recording fee. Get a complete breakdown of all costs before you proceed.

Third, what is the current mortgage interest rate on the property? If it is higher than rates currently being charged, you might want to consider having your mother refinance first, so as to take advantage of that lower rate. After that, you can have the property transferred into your name.

Finally, I strongly recommend that you advise your mother's lender of your plans. While they probably have no reason to challenge your decision, it is always best to keep the lender informed -- before you take any steps to change the ownership.

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Benny L Kass

Author of the weekly Housing Counsel column with The Washington Post for nearly 30 years, Benny Kass is the senior partner with the Washington, DC law firm of KASS LEGAL GROUP, PLLC and a specialist in such real estate legal areas as commercial and residential financing, closings, foreclosures and workouts.

Mr. Kass is a Charter Member of the College of Community Association Attorneys, and has written extensively about community association issues. In addition, he is a life member of the National Conference of Commissioners on Uniform State Laws. In this capacity, he has been involved in the development of almost all of the Commission’s real estate laws, including the Uniform Common Interest Ownership Act which has been adopted in many states.


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