Why this matters: This article covers exceptions and waivers to the enforceability of the due-on clause present in all trust deeds and enforced on sales only during a cycle of rising long-term fixed rate mortgage (FRM) rates.
Part 1 of this multimedia article series explores when the due-on clause is used in an interest rate cycle to interfere with sales, leasing and mortgage transactions.
Part 2 of this series examines how the due-on clause relates to assignments of leases for longer than three years, and the further encumbrance and foreclosure by junior lienholders.
Due-on-death
Transfers of interests in real estate which trigger due-on enforcement by a mortgage holder include the inevitable transfer of ownership resulting on the death of a vested owner.
However, as with due-on enforcement exceptions on a further encumbrance, very narrow exceptions apply to bar a mortgage holder from using the due-on clause to call the mortgage on the death of an owner who occupied the one-to-four unit residential property encumbered by a mortgage originated to fund a consumer purpose.
For example, consider the transfer of ownership to a one-to-four unit residential property, subject to a consumer-purpose mortgage with a due-on clause, to a relative on the death of the owner. The relative indicates they intend to occupy the property but rejects the mortgage holder’s offer of an assumption and modification agreement. The mortgage holder demands to waive its right to call the mortgage.
Is the mortgage holder permitted to call the loan or enforce any change in the terms of the mortgage due to the transfer of ownership by death to the relative who indicates they will occupy property?
No! The due-on clause in a consumer purpose mortgage (which only encumbers an owner-occupied, one-to-four unit residential property) is not triggered by the death or the transfer so long as the relative taking title intends to become an occupant of the property.
However, this exception to enforcing the due-on clause is conditioned on the lender’s confirmation that the relative taking title becomes or will become an occupant of the property. [12 Code of Federal Regulations §191.5(b)(1)(v)(A)]
In a different family residence situation, two or more people hold title as joint tenants to a one-to-four unit residential property subject to a consumer-purpose mortgage with a due-on clause. On the death of a joint tenant, that co-owner’s interest ceases to exist and the other joint tenant becomes the sole owner of the property.
Does the death of one joint tenant trigger the due-on clause and permit the holder of a consumer-purpose mortgage (again, always encumbering an owner occupied one-to-four unit residential property) to call the mortgage debt due?
Yes, unless at least one of the joint tenants, either the deceased or a surviving joint tenant, occupied the property when the mortgage was originated — which of course is a requisite for a consumer-purpose mortgage.
Curiously, the surviving joint tenant need not occupy nor intend to occupy the property to qualify as an exception to the mortgage holder’s use of the due-on clause. Here, the surviving joint tenant may rent out the property as an investment opportunity. [12 CFR §191.5(b)(1)(iii)]
Thus, due-on enforcement is triggered on:
- the death of any vested owner of a consumer mortgaged one-to-four unit residential property by a transfer of the deceased’s ownership to a non-relative, by will or inter vivos trust, following the death of the owner;
- the death of a joint tenant owning a one-to-four unit residential property which was not originally occupied by either of the joint tenants;
- the death of a co-owner of any type of property other than an exempt transfer of a consumer-mortgaged one-to-four unit residential property; and
- the transfer of any property, other than an exempt transfer of a one-to-four unit residential property encumbered by a consumer-purpose mortgage, to anyone on the death of the owner. [12 CFR 191.4(b)]
These inter-family due-on clause exceptions are for estate planning to keep wealth within the family, not to increase the earnings of mortgage holders or allow transaction agents to earn a fee.
Divorce and inter-family transfers
Consider a married couple who occupies a one-to-four unit residence vested in the name of the husband as separate property. The residence is encumbered by an owner-occupant consumer mortgage containing the boilerplate due-on clause.
The couple separates and the residence is transferred to the wife as part of the property settlement to dissolve the marriage. The wife continues to occupy the residence.
Here, the holder of a consumer-purpose mortgage is barred from due-on enforcement. The transfer of a one-to-four unit residential property to a spouse in a divorce is an exception to due-on enforcement under a consumer mortgage, so long as the acquiring spouse occupies the property. [12 CFR §191.5(b)(1)(v)(C)]
However, when the acquiring spouse in a divorce chooses to lease the property for any period of time rather than occupy it, the mortgage holder may call or recast the mortgage. Thus, a change in family use to income property use triggers the due-on clause and additional earnings for the mortgage holder when the owner acquires title in a divorce. Again, this scenario is only experienced in a long-term period of higher trending mortgage rates.
Inter-family exception
Similarly, an owner’s transfer of their one-to-four unit residential property to a spouse or child who occupies the property does not trigger the due-on clause in a consumer mortgage encumbering the property. [12 CFR §191.5(b)(1)(v)(B)]
Keep in mind this inter-family transfer exception to due-on enforcement in consumer-purpose mortgages applies only to transfers from an owner to a spouse or child. Any transfer from a child to a parent or between children triggers due-on enforcement.
Consider an owner who intends to transfer title to their one-to-four unit residential property into an inter vivos trust vesting, naming themselves as beneficiary for estate planning purposes. The property is encumbered by a consumer mortgage with, of course, a due-on clause in the trust deed. The owner continues to occupy the property.
The owner, as required, notifies the mortgage holder about their intentions prior to transfer into the inter vivos trust vesting, the owner taking title as trustee. The owner agrees to give the mortgage holder notice of any later transfer of their beneficial interest in the trust or change in occupancy of the property as properly requested by the mortgage holder.
Does this mortgage holder-approved transfer into the inter vivos trust trigger the due-on clause in a mortgage encumbering the owner’s residence?
No! The owner met the federal regulatory conditions for avoiding due-on enforcement based on a transfer of a consumer-mortgaged, owner-occupied, one-to-four unit residential property into an inter vivos trust vesting. [12 CFR §191.5(b)(1)(vi)]
To meet regulations, the owner needs to provide the mortgage holder an acceptable method for the owner giving the mortgage holder notice of any later transfer of the beneficial interest in the trust or change in occupancy. Critically, an owner conveying title to property into an inter vivos trust without the mortgage holder’s approval allows the mortgage holder to call the mortgage due, unless exempt as a consumer mortgage encumbrance.
Further, when the owner does not continue to occupy the property, or later transfers the beneficial interest in the trust, the mortgage holder may call or recast the mortgage — unless a different family exemption from due-on enforcement exists. The policy keeps property in the family and out of the open market.
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Preempt the lender by negotiations
An owner of a parcel of real estate encumbered by a mortgage decides to market the property as available for either a sale, lease or further encumber (to borrow funds, the ATM effect).
One sales approach to consider in tight or high mortgage rate market conditions is for the owner to preemptively contact the mortgage holder before marketing the property. Here, the owner is able to negotiate a limitation or waiver of the existing mortgage holder’s due-on rights without the existence of a transaction giving the lender a negotiating advantage. The negotiations will determine whether the lender will cooperate to keep the mortgage on the books by working with the owner to facilitate a transaction. [See RPI Form 410]
Through negotiations to arrange a suitable arrangement for a buyer assuming the existing mortgage, the owner preempts any mortgage holder overreaching interference with a future transaction. Otherwise, expect the mortgage holder to call the mortgage due when you have already entered an agreement to sell, lease or further encumber the property.
The mortgage holder interference with a buyer of a property subject to their mortgage typically is a sterile written notice to the owner composed in a cordial tone which masks its underlying intent to interfere. The owner is advised a transaction has recently come to their attention: please call to accommodate necessary arrangements.
Think of these prior negotiations this way: waiver agreements are trade-offs. In return for waiving or agreeing to limit the exercise of its due-on rights in the future, the mortgage holder may demand an exaction of valuable consideration such as:
- increased interest rate;
- increased amount of monthly payment;
- additional points, like an origination;
- an assumption fee;
- principal reduction;
- a shorter due date; or
- additional security or guarantees. [See RPI Form 410]
The waiver needs to be written for the owner to enforce a waiver agreement against the mortgage holder. [12 CFR §191.5(b)(4)]
Editor’s note – Expect stonewalling by the lender when negotiating a waiver agreement. It is in the lender’s best financial interest to stall when others are eager to make or close a deal. Time is on the lender’s side in negotiations, so start discussions early, on or before marketing the property for sale or lease (more than a three-year term).
Some mortgage holders may simply call when they become aware the owner has entered into a purchase agreement. The claim: the buyer has acquired an equity interest in the property as they hold the right to buy, as in an option to buy.
Consider a buyer who applies for a mortgage to purchase a residence they intend to occupy for only a few years. The buyer is informed by their agent that the mortgage will contain a due-on clause. It is foreseeable the clause may well make a resale of the property more difficult to achieve. Mortgage rates are likely to continue to rise in the coming decade since we have transitioned past the lower-bound interest rates of 2013.
The buyer and lender negotiate the terms and conditions of the origination, which is reduced to a writing, for a buyer in a later sale. Thus, a future buyer may assume the MLO’s mortgage without triggering a call by the mortgage holder.
In exchange, the buyer on origination agrees to pay increased points or a higher interest rate, subject to applicable Reg Z fee caps.
Now, keep in mind the mortgage holder’s waiver of their due-on rights only applies to the singular event of the assumption agreement later entered into by a future buyer. Waivers, unless worded differently, only apply to one transfer to the mortgage-assuming buyer, and no further transfer to another future buyer.
Unless additionally agreed to, any other transfer of an interest in the property will trigger the due-on clause. The mortgage holder may then call or recast the mortgage again for ever greater profits as an adjustment to a fixed rate mortgage.
Lender waiver by conduct
In addition to a formal written waiver agreement, waiver of the mortgage holder’s due-on rights may occur by mortgage holder conduct. Mortgage holders and their servicing agents often fail to promptly enforce their due-on rights by calling and refusing to accept installment payments when they have reason to know a transfer occurred. [See RPI Form 410]
For example, consider a buyer who purchases real estate subject to a mortgage containing a due-on clause. The buyer makes the payments on the mortgage after taking title, which the mortgage holder or their servicing agent accepts.
The mortgage holder later discovers facts alerting them to the transfer and promptly calls the mortgage. Now, by the call, only one balloon-type payment is due in the payment of one installment, the amount of the call.
But then the mortgage holder behaves strangely, inconsistent with the call. They or their servicing agent continues to accept monthly installment payments from the buyer for several months. The period of accepted payments is longer than a reasonable time to enforce a call by refusing payments and foreclosing for the buyer’s failure or refusal to pay the balance due as set in the call.
After later increases in interest rates on new originations, the mortgage holder then refuses further payments — other than payment in full satisfaction — and starts foreclosure to enforce their earlier or initial call.
Can the mortgage holder, after accepting payments from the borrower following their discovery of the transfer or any call for payment of a lump sum payoff, later attempt to call or foreclosure?
No! Here, the mortgage holder waived the right to enforce their due-on clause by their conduct. [Rubin v. Los Angeles Federal Savings and Loan Association (1984) 159 CA3d 292]
After discovery of the transfer or their call for payoff, they accepted payments inconsistent with due-on clause enforcement — the one installment remaining payable on the call. The mortgage holder may not later foreclose to enforce a call. They waived right to call or enforce a prior call by continuing to accept payments long after having knowledge of the transfer or their call.
Broker liability when masking the change of ownership
When the mortgage holder discovers a change of ownership has taken place, their only remedy against the buyer and seller is to call the mortgage due or arrange to recast the mortgage as a condition for waiving their right to call and allowing an assumption by the buyer.
Additionally, the mortgage holder may not recover for the seller or the buyer any amount of retroactive interest differential (RID) for the period before they discovered the transfer and called the mortgage. [Hummell v. Republic Federal Savings & Loan (1982) 133 CA3d 49 (Disclosure: the legal editor of this publication was the attorney of record for the owner in this case)]
However, an advisor, such as a broker or attorney, might be assisting the buyer or seller to intentionally mask the change of ownership from the mortgage holder with the primary purpose of avoiding detection and due-on enforcement. Thus, an advisor might wrongfully interfere with the mortgage holder’s right to call or recast the mortgage, conduct called tortious interference with prospective economic advantage — of the lender, of course.
The advisor’s liability arises based on the extent to which their actions were specifically intended to conceal the transfer with the primary purpose of preventing a call by the mortgage holder. It is about the foreseeability of the mortgage holder to incur losses due to the concealment. [J’Aire Corporation v. Gregory (1979) 24 C3d 799]
The mortgage holder’s losses caused by the adviser’s wrongful interference are calculated based on the interest differential between the note rate and the market rate on the date of sale closed — the spread — retroactively applied from the date from closing to the date of discovery by the mortgage holder.
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