September 21, 2011

Due-on-sale Clause - Garn-St. Germain Depository Institutions Act of 1982

Whenever a homeowner purchases a piece of property that is encumbered by a loan, the lender will invariably attach a provision to the loan known as a due-on-sale clause. The following are some questions that address this topic.

1. What is a due-on-sale clause?

Federal law defines a due-on-sale clause as “a contract provision which authorizes a lender, at its option, to declare due and payable sums secured by the lender’s security instrument if all or any part of the property, or an interest therein, securing the real property loan is sold or transferred without the lender’s prior written consent is a provision in a deed of trust that provides the lender the right to accelerate the secured obligation if the owner transfers the property.” 12 USC §1701j-3(a)(1).

2. What does this mean in everyday language?

A due-on-sale clause gives the lender the right to demand full payment of the loan immediately if the borrower tries to transfer the property without the lender’s approval

3. How does a due-on-sale clause work in real life?

Assume Bud purchases a home from Al. Bud obtains financing from a bank in order to make the purchase. Bud then executes a loan in favor of the bank, which contains a due-on-sale clause. One day Bud decides that he wants to sell the home to his neighbor Jefferson. However, in light of the due-on-sale clause, before a transfer from Bud to Jefferson can take place, the full amount of the loan will need to be paid off because Bud’s attempted transfer would trigger the application of the due-on-sale clause.   

4. Are all transfers of real property subject to due-on-sale clauses?

No, the Garn-St. Germain Depository Institutions Act of 1982 carves out a number of exceptions to the general rule that a transfer of encumbered real property triggers a due-on-sale clause. Pub L 97-320, 96 Stat 1469. Although these exceptions only apply to “a real property loan secured by a lien on residential real property containing less than five dwelling units.” 12 USC §1701j-3(d). Thus, commercial property secured by a deed of trust would not be subject to the protections of Garn-St. Germain. Regardless, if the loan involves residential real property, Garn-St. Germain applies in some situations.  For example, a due-on sale cannot be triggered on "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." 12 USC §1701j-3(d)(8), see also California Civil Code § 2924.6(a)(4).