As you likely already know, offering the option of seller financing can be an effective way to make purchasing your home an option for a greater variety of buyers. However, you may not be aware that, if you have an existing home loan, the process will become a little trickier, mainly due to the due on sale clause in your mortgage.
First, you may want to know, “What is a mortgage clause?” Put simply, a mortgage clause is a provision in your loan that is meant to protect the lender. In particular, the due on sale clause in real estate loans allows the lender to demand that the loan be paid in full when the deed is transferred.
Read on below to learn more about what this clause is, how it works, and how you can protect yourself while still getting the chance to offer seller financing to the buyer of your choice.
What is a due one sale clause?
A due on sale clause definition can be summed up fairly easily by explaining that this clause is a provision in most mortgages that states that the loan must be paid in full upon the sale or transfer of ownership of the property. Also sometimes referred to as an “acceleration clause” or a “wrap-around mortgage due on sale clause”, this provision means that the loan will not be assumable and that the seller of the property will typically need to use the proceeds from the sale of their home to pay off the loan.
Ultimately, lenders prefer when a loan is due on sale because it protects them from having the loan transferred to a new owner when the rate on the loan is below current market rates. In general, holders of a mortgage with a below-market rate – or secondary mortgage market products that are backed by below-market-rate loans – tend to prefer that the loan be retired early.
Notably, there are a few due on sale clause exceptions, unfortunately, they are not applicable to owner financing. For example, this clause is not triggered if ownership of a property is transferred due to divorce or inheritance. In the event that you aren’t related to the new buyer of your home, you likely will not be covered under these exemptions.
Due on sale clause example
Before we get any further into the methods you can use to work around a due at sale clause in your loan, it might be useful to take a closer look at a due on sale clause example so that you have a better idea of what to expect from this provision. With that in mind, we’ve provided an example below:
For the purposes of this example, let’s say that John originally took out a $300,000 loan when he bought his home. Let’s say, after a few years of paying down his mortgage, John decides to sell his home even though he still has a $150,000 loan balance left. Fortunately, after being on the market for a little while, John gets a $325,0000 offer on his home.
At closing, the due on sale clause in John’s original mortgage comes into play. In order to transfer the deed to the property to the new buyer, John must first pay off his remaining loan balance. Therefore, he uses $150,000 of the proceeds from the sale of his home to satisfy his debt to his lender, which leaves him with a total of $175,000 in profit.
The risks of trying to dodge a due on sale clause with a wrap around mortgage
Many buyers will try to circumvent due on sale clause by offering up the possibility of a wrap around mortgage. A wrap around mortgage is essentially a junior loan that encompasses the cost of the existing loan, plus the cost of any equity in the property. With one of these loans, the buyer is responsible for making a regular installment payment to the seller. The seller, in turn, is responsible for using a portion of that payment to pay down the original mortgage loan.
In some cases, the deed of trust will be signed over to the buyer. When that happens, a lien will be placed on it for the amount of the existing mortgage loan, plus any additional amount that the new buyer owes to the seller. Traditionally, the wrap mortgage will have a higher interest rate than the primary home loan so that the seller will be able to make a small profit in exchange for the trouble.
A wrap around mortgage more or less allows the seller and the borrower to get around the due on sale clause because, as long as the primary home loan is still being paid in a timely manner, the lender is unlikely to enforce the due on clause. However, agreeing to this wrap mortgage due on sale clause workaround is also inherently risky.
For one, if the buyer stops making payments toward the wrap around mortgage, the seller will still be responsible for making their payments on the original loan. For another, if the lender finds out about the transfer of the deed, they could ultimately exercise their right to the due on sale clause and then the loan would need to be repaid in full.
How having a due on sale clause in an existing mortgage affects the creation of a private mortgage note
In order to avoid this fate, some sellers simply do not inform their mortgage company that they will be entering into an owner financing arrangement. After all, the lender will have very little reason to invoke the mortgage due on sale clause if the loan is paid in a timely manner, as would be the case if you entered into a successful wrap around mortgage.
However, knowing the risks, you’ll have some additional considerations when putting together your private mortgage note. You’ll either want to construct the note so that it has a large enough down payment to pay off your existing loan or ensure that the deed to the property will not be transferred to the new buyer until such time as you are able to pay the loan off in full.
Once created, you could also sell your mortgage note to a note buyer like Amerinote Xchange. Loans that contain due on sale clauses are generally considered preferable when selling a mortgage note. However, they are not always necessary. For example, they are usually seen in longer-term loans, where the loan is paid off in decades. They are not as common in short-term loans, such as fix-and-flip loans.
The bottom line
If you have an existing loan on your home, the due on sale clause makes offering owner financing on your home riskier than if you owned it outright. However, by making sure to structure your mortgage note carefully and by considering selling your note to a qualified buyer, you can protect yourself from the possibility that your lender will one day call your entire loan due. Together, these options will allow you to safely and confidently offer seller financing for the sale of your home.