Question: I have a couple of questions regarding due-on-sale clauses and inter vivos (living) trusts which you discuss on page 182 (digital version) of first tuesday Real Estate Finance.

Could you point me to any authority which has pinned down the amount of beneficial interest transferred that would trigger the due-on-sale clause?

Answer: Your questions about lender use of the due-on-sale clause once interest rates begin to rise are prescient. Interest rates were stuck on a continuous upward trajectory after World War II through to the end of the ‘70s. As interest rates rose during this 30-year period, the lenders’ use of due-on clauses became a seriously burdensome issue for the real estate community since its existence significantly limited sales volume.

Likewise, commencing around 2014-2015 and likely continuing for the next 30 years (similar to the post-Great Depression era), interest rates will rise – they cannot go down. (Incidentally, rising interest rates are indicative of a positive thing, lest we suffer a bout of economic stagnation and decades of low interest rates similar to the one experienced in Japan during the past 20 years.)

With the rise of interest rates, lender use of the due-on clause to interfere with sales solely to increase portfolio yields will return, becoming an increasingly problematic hindrance damping down huge numbers of sales that properly would have occurred had lenders not been able to interfere without good cause to protect their security interest in the property. [For more information on the stifling effect the due-on-sale clause has on the California real estate market, see the March 2011 first tuesday article, The due-on-sale clause: barricading homeowners since ’82.]

The transfer of any interest in real estate, with the exception of transfers of title between family members and further encumbrances of a principal residence, and leases of any property not exceeding three years, triggers the due-on clause.  To avoid a call or modification, a written pre-conveyance consent by lenders with due-on clauses in their trust deeds is required. [12 Code of Federal Regulations §591.5 (b)(1)(vi)]

To directly respond to your question, the due-on-sale clause is triggered on the owner’s voluntary or involuntary transfer of any equitable or legal interest in the secured property (with the exception of some interfamily transfers of the principal residence), a security interest (with the exception of seconds trust deeds on principle residences), or a leasing of the property for any term greater than three years.

Due-on-sale interference by lenders since 1982 is primarily an economic issue due to federal regulations, not the legal issue it previously was. When interest rates subside as they have for the past 30 years since 1980, existing loans at the time of the sale, further encumbrance or leasing typically had a higher rate of interest than new loans.  Thus, lenders holding an existing loan on a property had no financial incentive to call loans due or recast them by modification on a transfer.

Transfers of title into a homeowner’s living trust vesting of an owner-occupied, one-to-four unit residential property are exempt from due-on enforcement.  [12 United States Code §1701j-3(d)(8)]

Inter vivos (living) trusts are occasionally improperly used to mask a sales transaction. Trusts established in California to hold title to property are not entities, with the exception of real estate investment trusts (REITs).  Trusts other than REITs are mere title holding arrangements for the true owner of the real estate. Further, an interest in real estate is only converted to personal property when a limited liability company (LLC), limited partnership (LP) or corporation (Corp) is created and stock (certificate of membership) is received by the owner  in exchange  for transferring ownership of the real estate to the entity.

Consider the ownership issue created when an individual funds two irrevocable trusts with money and names his daughter as the sole beneficiary of both. Although the individual had no legal interest in either trust, he controls the trustee and receives all benefits and earnings associated with the two trusts.

The individual files a petition for bankruptcy and does not include the two trusts and their assets as part of his estate.

The bankruptcy administrator seeks to recover the assets held in the two trusts to pay the individual’s creditors. The claim on behalf of the creditors is that the assets of the two trusts are part of the individual’s bankruptcy estate since the individual received all benefits and earnings from the properties in the two trusts, conduct making him the true owner of properties vested in the trustee.

The individual claimed the assets held in the two trusts were not part of his bankruptcy estate since he held no legal interest in either trust, thus making him owner of the properties held by the two trusts impossible. The bankruptcy court held the assets of the two trusts in which the individual has no legal interest but received all benefits and earnings of the trusts are part of that individual’s bankruptcy estate since the individual’s conduct of receiving all the benefits of ownership established his equitable ownership of the assets in the first trust and an alter-ego ownership of the assets in the second trust. [See the upcoming first tuesday Recent Case Decision; In re Schwarzkopf (November 23, 2010) _BR_]


Question: A second aspect I was wondering about concerns “occupancy.”  Since CFR §591.5(b)(1)(iv) specifically allows an owner to lease (and not necessarily actually “occupy”) a single family residence (SFR) for terms of up to three years, this privilege seems to be a right associated with his “occupancy.” Is this correct?

Answer:  An owner’s right to occupy the property he owns remains with him until he enters into a lease agreement and delivers possession to a tenant. Ownership and occupancy are separate issues, and there is no requirement by regulation or code that the owner occupy the property he owns (with the caveat that the due-on clause interferes with transfers of occupancy with a term exceeding three years).


Question: I’m not very clear about the meaning of CFR §591.5(b)(1)(vi) where it states, “…as a condition precedent to such transfer, the borrower refuses to provide the lender…”  Does the use of “refuses” rather than something more general such as “neglects” indicate that some type of demand or request must be made of the seller?

Answer: This has to do only with the trust agreement under the regulations. The transfer may be completed only after the trust agreement has been approved by the lender under the regulation.  No known situation of the lender reacting to a refusal by the owner to supply proper conditions so that any further transfer of the beneficial ownership to another person will be brought to the lender’s attention exists. Nothing exists reviewing a lender’s refusal to agree to a request by the owner for the lender to approve the inter vivos trust agreement so the owner may transfer title to the owner’s inter vivos/living trust.

For a thorough review of the proper purpose and use of a revocable inter vivos/living trust vesting as a method to avoid probate supervision of a deceased owner’s estate, see first tuesday Legal Aspects of Real Estate Chapter 32, The revocable title holding trust. This book is accessible from within the Library section of the student homepage and from the first tuesday Forms-on-CD 4.3 which comes with all enrollment packages.