THE DUE-ON-SALE CLAUSE -- HOW TO AVOID IT

Bill J. Gatten
North American Realty Service, Inc., Author: No Down! No New Loan!

The Common Assumption: To get around a lender’s due-on-sale clause, one must just go ahead and violate it, and then try to make sure the lender doesn’t find out.

The Facts: The due-on-sale clause is not violated when a transfer of real estate ownership is by assignment of beneficiary interest in an inter-vivos trust, versus a conveyance by a title transfer.

The Common Assumption (“Denial”): Lenders’ don’t mind if a loan is taken over by another party without their permission. They obviously would never want to foreclose on a perfectly good, properly performing, well secured Account Receivable…especially in “this” market.

The Fact: Lender’s are conglomerations of investors (humans) who do care in a big way, but whom will usually turn away and pretend they don’t see anything wrong during times when mortgage rates are low. However, when rates start to climb and they see an opportunity to replace old, poorly performing loans with significantly higher yields for their stockholders, they suddenly begin spending considerable effort in seeking out those opportunities (like foreclosing on unauthorized transfers and fraudulently applied-for loans).


Interesting, however, one can indeed take over an entirely non-assumable loan without needing to fear, or even be concerned with, a DOS Violation. To do so, one need merely place the property into a co-beneficiary land trust in the mortgagor's (seller's) own name and take a partial Beneficiary Interest in it. The trust would then be set up to run for some specified period of time, with the understanding that, at the end of that period the seller's interest will be forfeited to the "buyer" without further claim. Such forfeiture merely needing to be in consideration of some promise of a future act by the buyer (e.g., prompt payments; strict adherence to contract terms; a share in appreciation or overall profit; etc.).

The problem confronting most of us is that the foreboding due-on-sale clause in Para. 17 of the loan agreement doesn't always say what we (or our attorneys) “think” it does, irrespective of whether a lender's rights under a DOS clause are "real," "false" or indifferent. What the clause actually says is: UNLESS PROHIBITED BY LAW, the lender has a right to foreclose if...". Well, good news! Such right is not available under the law (12 USC 1701(j)). Make no mistakes about it, a lender’s foreclosing due to a borrower’s placing its property into a living trust (assuming the trust is revocable and that the borrow remains a beneficiary), IS in fact against the law. That law is the “Federal Depository Institutions Regulations Act,” known as the FDIRA, having originated with the “Garn-St. Germain Act” of 1982.

Under Garn-St. Germain, a mortgagor’s (borrower’s) rights as established by the federal government, allows any borrower to grant its own mortgaged property to its own living trust, and subsequently name (a second party) as a Co-Beneficiary in that trust. When this is done, if your are that second party, the property has effectively been transferred to you, along with 100% of all the benefits and incidents of real property ownership. And the transfer does not need a new loan or any more cash than the seller might require. As well, the due-on-sale clause has not been tampered with. Title hasn’t been transferred beyond the authorized trust. No control over the property has been relinquished by the borrower of record. The lender’s security interest remains fully intact. There need be no public notice (recording) of the transfer to you; and the property is now shielded from either party’s judgment creditors, tax liens, lawsuits, divorce actions, bankruptcy, probate and estate tax issues.

PRACTICAL USE: When calling on a prospect that you’d want to remain on the loan, if you want to be assured of 'getting the deal,' make it sound so good for the seller that he can't refuse. Suggest to him that for his own safety and peace of mind, you'll pay to put the property into a neutral title-holding trust in his own name. Explain, as well, that he needn't ever transfer the property’s title to you at all…until you've had a chance to prove yourself by selling the property and paying off his loan, or refinancing it in your own name. Explain that you'll consent to being merely named a co-beneficiary in the trust, until such time as you retire his loan in, say, a year or two (or 3, 4 or 5 years…or more).

Note that this arrangement (called a "NARS PAC Trust") affords you the buyer 100% of the mortgage interest and property tax write-off; 100% of the Use, Occupancy, Possession; 100% of the Equity Build-Up (from principal reduction); full rights to all rents; and other profits upon the sale or other disposition of the property. In addition, you own and control every single right ordinarily available under the so-called "Bundle of Rights" in Fee-Simple Real Estate ownership.

In the NARS PAC Trust, the seller never has to take any chances with you; and you don't have to take any chances with the seller. While the property is protected from liens and lawsuits…on both sides, the Due-on-Sale Clause becomes pretty much a non-issue. That’s because the real estate interest in the property has not being sold; the title has not being transferred (beyond the borrower’s own living trust); there is no consideration or option for a purchase…yet); and that which is being transferred (beneficiary interest) is personal property only and not real estate, and therefore not the security for the mortgage loan.

As far as an attorney's suggestion that a Lease Option would be better, with reference to the Due-on-Sale Clause, that's ridiculous (and they do it all the time)! When an attorney makes such a suggestion, he/she knows nothing about Land Trusts or the Garn-St. Germain Law (12USC 1701(j)) per se. they merely are looking to make a profit on doing a deal for you that they understands better: but wholly at the expense of your maximum safety, tax write-off and income potential.

Despite what you may have heard or will hear to the contrary from time-to-time, all Lease Options, Lease Purchases, Wraps, Land Contracts or Equity Shares without the shield provided by the NARS PACTrust can, and do, more than just occasionally, constitute some or all of the following:

1) Lender’s Due-on-Sale violation (all)
2) Public notice of the transfer, or deception and legal risk by avoiding public notice (all)
3) Excessive risk of title involvement with the other party’s marital disputes, BK's, creditor judgments, tax liens, lawsuits, illegal activities and probate issues (all)
4) Loss of tax write-off for the resident party (contracts and options),
5) Possible property Tax reassessment (contracts, wraps and equity shares)
6) Difficulty in procuring title insurance
7) Difficulties with hazard insurance replacement and coverage (contracts and options)
8) Much lower income potential for the investor (contracts and options)
9) Much higher potential for difficulty in eviction and dispossession of an errant or defaulting tenant buyers who would claim “Equity” to force judicial processes versus eviction (all)
10) Need for subterfuge in dealing with lenders, insurance carriers, co-buyers, etc. (all)
11) Confusion and lack of control in timely payment and determining how payments are to be received and disbursed to creditors (all).

To find out more about Landtrust and Equity Transfers Using Landtrust, Click Here.