The Due-On Clause Strikes Back
Whenever the real estate market enters a vicious cycle — characterized by rising rates, falling sales volume and decreasing prices — the dreaded due-on sale clause once more becomes an issue for mortgaged sellers.
The single greatest burden on the use and mobility of commercially available title for ownership of property rights is created by the existence of the due-on clause buried within all trust deeds held by mortgage lenders and carryback sellers.
During long-term cyclical episodes of declining fixed rate mortgage (FRM) interest rates such as during 1983 to 2012, the due-on clause is a non-issue. The clause lays dormant, unused for lack of its ability to increase mortgage lender and servicer profits beyond the earnings bargained for at the time of origination.
However, booms always turns to bust – cycles are always completed.
In a vicious cycle or recession, buyers return to purchase property after prices fall. Here, the most efficient sale arrangement for financing the purchase price is for the buyer to take over the seller’s mortgage — but only when it has an interest rate lower than the rates currently demanded by mortgage lenders.
But there is a catch — a due-on catch. That catch is a home-run hit for existing mortgage holders and servicers.
Mortgage holders in periods of rising FRM rates refuse to consent to any type of mortgage takeover or assumption by buyers. The reason: they prefer a payoff as the payoff funds allows them to re-lend the money at the higher current FRM rate. When the payoff is within three years of origination, the lender also demands a prepayment penalty as additional income triggered by forced sales typical in a recession.
Thus, the FRM – once believed by the owner to be reliably unalterable – becomes a VRM (VaRoom! mortgage).
An assignment by a tenant or modification by an owner of an existing lease does not trigger the due-on clause in a trust deed encumbering fee title, unless the owner:
- modifies the lease by extending the term beyond three years; or
- grants the tenant a purchase option.
Here, we discuss further instances in which a mortgage holder may properly exercise the due-on clause in a trust deed – on a further encumbrance of a property or foreclosure by a junior lienholder.
As with due-on enforcement triggered by a further encumbrance, very narrow exceptions apply to the death of an owner of a one-to-four unit residential property encumbered by an owner-occupant consumer-purpose mortgage.
This episode illustrates negotiating a limitation or waiver of the existing mortgage holder’s due-on rights, and a mortgage holder’s waiver of their right to enforce the due-on clause by their conduct.