As a borrower, you may sign dozens of papers at your real estate closing. These mortgage documents govern your relationship with your lender while you are repaying your mortgage loan, and it is likely your mortgage contains a due on sale clause. Lenders commonly place such clauses in mortgage contracts to force borrowers to pay their mortgage in full before transferring the property to someone else.
Due on sale clauses discourage buyers from transferring their mortgage to someone else, such as a subsequent buyer, by forcing borrowers to pay their mortgages in full before transferring the property. This keeps subsequent buyers from assuming the original borrower’s loan, forcing him to obtain his own loan. For example, if you obtain a mortgage loan at 3 percent interest but want to sell your home 15 years later when interest rates are at 15 percent, a buyer may want to assume the remainder of your loan rather than getting his own more expensive loan. Lenders insert due on sale clauses to force subsequent buyers to get new loans at higher interest rates.
The clauses were introduced prior to the Home Owner’s Loan Act of 1933 which changed the home mortgage system by allowing lower interest rates and providing federal insurance programs to guarantee loan repayment. The act included regulations regarding due on sale clauses, but the clauses became common again during the 1970s when interest rates increased, encouraging subsequent buyers to find more creative ways to finance their home purchases. Since home loan interest rates were in the double-digits during this time, due on sale clauses represented a way for lenders to make more money on interest when real estate changed hands.
The Federal Home Loan Bank Board issued regulations regarding due on sale clauses in 1976, but confusion between these regulations and state laws prompted Congress to pass the Garn Act in 1982 to regulate due on sale clauses nationwide. Federal law specifically permits due on sale clauses for real property loans. The law states such clauses operate by the terms of the clause and the mortgage agreement rather than by standardized federal rules though the law encourages lenders to permit loan assumptions at the existing mortgage’s rate.
For loans on real property that has less than five units, federal law prohibits lenders from exercising their due on sale clauses under certain circumstances. For example, when a borrower dies and his property is transferred to a relative, the lender cannot force immediate payment in full. Other exemptions include transfers in which the borrower’s spouse or children become property owners, transfers into trusts in which the borrower is a beneficiary or transfers resulting from divorce or legal separation.
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