Mortgages almost universally have “due on sale” clauses in the event that a mortgaged property is transferred, which require that the entire “accelerated” balance of the mortgage be paid at the time of the transfer. This is fine in the case of a sale of mortgaged real estate because the sales proceeds are available to pay the mortgage off. However, in many moments (many of life’s most stressful moments, in fact) the “due on sale” clause could cause real hardship. Think, for example, of a transfer of property to the estate of the owner or the heirs of an owner upon the owner’s death or of the very common occurrence of a transfer to an ex-spouse as part of a divorce settlement.
Fortunately, a federal law known as the The Garn-St. Germain Depository Institutions Act of 1982 (usually known as just Garn-St. Germain) steps in to re-dress these situations as well as a few other situations that life presents us with. The law applies to mortgaged residential property “containing less than five dwelling units” and prohibits the operation of the due on sale clause in nine different classes of transfers. Some of the more common “exempt” scenarios are listed below.
- For inheritance purposes (when the new owner has survived the previous Owner):
- The transfer by devise (that is, a transfer to a deceased owner’s beneficiary under a Will) or by descent (that is, a transfer to a deceased owner’s heirs under intestacy if the deceased owner did not have a will);
- A transfer to a co-owner with right of survivorship or a surviving spouse who owned the property “by the entireties” (that is, ownership listed on the deed as “husband and wife”); and
- A transfer to a relative resulting from the death of a borrower.
For Estate, Tax or Financial Planning purposes (providing for family and yourself during your lifetime):
- A transfer where the spouse or children of the borrower become an owner of the property; and
- A transfer by a borrower into an inter vivos trust under circumstances where the borrower is a beneficiary and the right to occupy the property does not change.
In the event of divorce:
- A transfer resulting from a decree of a dissolution of marriage, a legal separation agreement, or from a property settlement agreement by which the spouse of the borrower becomes an owner of the property.
Common Financing Transactions:
- Placement of a second mortgage or similar subordinate lien on the property (this would otherwise often be a violation of the first mortgage, which prohibits such liens);
- The creation of a “purchase money security interest” for household appliances. For example, if you bought a dryer on credit and the seller has the right to take the dryer back as collateral, this would not accelerate your mortgage balance, and make the loan immediately payable. (Ask yourself how surprised you would be if you bought a dryer and the bank decided to take your house. That “surprise” is likely the reason why this clause was included in Garn-St. Germain.)
Leasing the property:
- The granting of a leasehold interest of three years or less provided the lease includes no option to purchase.
This is a pretty extensive list of protections. One important thing to notice, however, is that it only protects the bank from calling the loan as a result of the transfer. Giving a property to your child, ex-husband, estate, etc. is by itself not reason to call the loan; however, there is no guarantee that your child, ex-husband, estate, etc. can actually pay the loan, and Garn-St. Germain provides no protection from that. After the transfer, a more basic rule of mortgage finance applies to the transferee: “you pay, you stay; you don’t, you won’t.”
In closing, it is important to know these rules. You may voluntarily engage in one of these exempt transfers, or you may have one of these situations thrust upon you in the case of a loved one’s death. Not all banks abide by these rules unless they are reminded of them. Given the clarity of these rules and some of the situations we have seen, it is not even clear that some banks know the rules (which are from 1982!). As ever it pays to know your rights; and it pays to know that even though your mortgage may say one thing, what the bank can do is often more limited.
— Rod Fluck