May I transfer property that has an existing mortgage?
In a real estate closing involving financing, among the various documents being signed, the purchaser/borrower signs two important bank documents, namely, the mortgage and a promissory note. The mortgage is a document that grants the bank a security interest in your home in lieu of issuing you the loan. The promissory note is your legal obligation to pay the bank the principal, interest, escrow, etc. Additionally, the purchaser/borrower receives the deed executed by the seller/transferor. The deed is the document that conveys title (ownership). This question calls concerns the interplay between the mortgage, the promissory note, and the deed in the following scenario:
Lender (L) has a mortgage on the subject property with a promissory note from Adam (A). Adam (A) now wants to transfer or sell the property to Bob (B). B intends to assume A’s loan. Can A transfer title to B, and likewise, can B assume A’s loan, when B does not have a legal obligation or relationship with the bank?
To answer the frequently asked question above, it is important to understand the contents of the promissory note that dictates the financial and legal obligations between you and your mortgage-lending bank. Specifically, it is crucial to understand that nearly all loans originated today contain a “due on sale clause.”
What is a “Due on Sale” Clause and Why is It Important?
The “due on sale” clause also known as the “acceleration clause” is a term in a promissory note document that grants the lender the right to demand payment of the remaining balance of the loan when the property is sold or transferred.
A typical “due on sale” clause reads:
“If all or any part of the property herein is transferred without the lender’s prior written consent, the lender may require all sums secured hereby immediately due and payable.”
This legal mechanism was implemented by banks in the early 1970’s when interest rates began to soar., to avoid a purchaser assuming the seller’s loan with more favorable terms and interest rates, than the current market had to offer. In effect, it was a way for banks to re-loan the money at current higher rates. Black’s Law Dictionary defines the “due on sale” clause as a device for “preventing subsequent purchasers from assuming loans with lower than market interest rates.”
Congress codified the enforceability of the “due on sale” clause in 1982 through the passage of Garn-St Germain Federal Depository Institutions Act. CLICK HERE
If the lending institution that has a mortgage on the property discovers that the real property was transferred without their written consent, it has the option of calling the full balance of the loan to become due (therefore “due on sale”) OR commencing foreclosure proceedings.
Exceptions to the “Due on Sale” Clause
Transferring property with a “due on sale” clause is a gamble. Legally, while the bank has the authority to call the balance immediately due or initiate foreclosure proceedings, they seldom do, so long as monthly payments are received. However, that is not to say, that the bank cannot and will not enforce their contractual rights.
The Garn St. Germain Act provided several exceptions in which the lender may not enforce the “due on sale” clause. With respect to a real property loan secured by a lien on residential real property containing less than five dwelling units, including a lien on the stock allocated to a dwelling unit in a cooperative housing corporation, a lender may not exercise its option pursuant to a “due on sale” clause upon:
- The creation of a lien or other encumbrance subordinate to the lender’s security instrument which does not relate to a transfer of rights of occupancy in the property;
- The creation of 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 interest of three years or less not containing an option to purchase;
- A transfer to a relative resulting from the death of a borrower;
- A transfer where the spouse or children of the borrower become an owner of the property;
- 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 that does not relate to a transfer of rights of occupancy in the property; or
- Any other transfer or disposition described in regulations prescribed by the Federal Home Loan Bank Board.
What is a Land-Trust? (Exception #8)
A land trust is a form of a revocable, living trust which is exempted under the Garn Act. A land trust is essentially a private agreement, whereby one party (the “trustee”), agrees to hold title to property for the benefit of another party or parties (the” beneficiary”). A land trust, like a living trust, is create by two legal documents:
- A trust agreement between the grantor of the trust and the trustee.
- A deed from the grantor 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.” After creating the trust, the beneficiary can freely assign his interest, as the beneficiary, to the trustee (the intended transferee).
If you place title to your property into a land trust, you have not violated the “due on sale” (so long as there is no change in occupancy). This type of trust agreement is not recorded, and the deed conveying the property to the trust does not identify the parties involved. The ownership of the property simply assigns the beneficial interest under the trust.
For more information on this topic or related real estate questions, please call Sergey Kalantarov, Esq. of Kalantarov Law, PLLC at (516) 953-9801.