Why The “Due on Sale Clause” Might Be a Bigger Deal Now

Cam Dunlap here today to talk about the due on sale clause in real estate.

Recently, a great question from one of my Inner Circle clients came my way.

Barbara asked:

“If you do an assignment with seller financing on some kind of wrap-around, is the seller’s institutional lender willing to work with you and accept your payments or will they call the loan due?”

Good question!

The Due on Sale Clause: What is it?

So, in the case of a wrap-around where the underlying loan remains, you may or may not actually get the deed. 

The seller might say, “Well, I’ll do a wrap-around. I’m going to take a payment that’s greater than what I owe on my $100,000 mortgage and that encompasses the other $50k, which is my equity, but I’m not going to deed the property to you. We’ll do it on a lease option… or an agreement for deed… or a land contract… or an all-inclusive trust deed.”

So, generally speaking, in the case of a wrap-around, the seller may or may not transfer title. 

If the title is transferred and the loan is not paid off, the seller/borrower is technically in violation of the “Due on Sale Clause.”

Basically, the Due on Sale Clause is a big, scary feature that’s there for a good reason: The lender wants to protect their interests. If the deed transfers to somebody else, without the loan being paid, they can call the whole loan due.

My Experience With Due On Sale

In my experience, I have never seen a lender call a loan due on me. Lenders just don’t often, if ever, exercise it, historically. There’s really no track record of actually calling those loans due. 

So, real estate investors are used to disregarding it and saying, “That’s a risk I’m willing to take, because it’s such a small risk.”

Now, I know of one scenario where an acquaintance of mine did have a lender call the loan due, but it’s a freak occurrence because the only way they can actually do that without your consent — meaning, without you capitulating and saying, “Fine, I’ll pay off the loan,” — is to foreclose. 

Foreclosure is their only remedy. And that’s expensive and time-consuming. And then they have a non-performing asset, which affects their ability to lend based on ratios that are set by the Fed.

So, any time a lender threatens that you’re in violation of the Due on Sale Clause and demands payment for the loan in full in 90 days… ignore it. Because the chances of them actually following through on that are close to zero. 

So, again, historically, this has not been an issue.

However, we’re in different times these days… I’ll explain…

This is interesting… 

I was teaching at an event years ago, and there was a guy there who ran the foreclosure team for SunTrust Bank, which is a huge southern bank that recently merged with BB&T to become Truist.

Anyway… 

I asked him about the bank’s policies and procedures with regard to the Due on Sale Clause: “What are the chances you would actually follow through on a threat and foreclose?”

And he said: “Almost never. Except in an environment where the face rate on the loan is very low and the current rates that we’re lending at is much higher.”

What he means is the delta between the face rate on the loan — what’s written into the contract and what they could lend the money for if they were to recover that money and put it back out by selling them off on the secondary market or perhaps hold it in their portfolios. 

All of that aside…

“When the delta between the face rate and the current rates is wide, then we might,” is what he said.

And I remember thinking that’s a good lesson for me, I’m going to file that one away. I actually haven’t thought about this in quite a while… but as you know, it just so happens we’re in that environment right now. 

Again, he said the only time they’d call that loan is if interest rates were higher than the fixed interest rate on that loan, significantly enough that the delta between the two is an incentive for the lender to call it due.

In other words, if the lender can reclaim the funds and lend them out instantly at a higher rate — they’re likely to. 

Now, with interest rates significantly high these days, the Due on Sale Clause is potentially a bigger threat for investors who think that it’s usually not a big deal. Because the lender could call the loan and put it back out at a much higher rate… rates like we’re experiencing now. 

The higher the rate, obviously, the more the lender will make.

See, a lender can deny a loan for any doggone reason they want. But what they’re really doing is resetting the rate, because you’re locked in at a rate much lower than the market, so they’re adjusting to overcome that.

So right now, you might see a lender follow through on that Due on Sale Clause threat if they’re confident they could put the money out at a much higher rate.

Final thoughts…

I should point out that I’m not saying that the Due on Sale Clause is an imminently bigger threat than it’s ever been.

But I am saying that you’d be wise to follow my lead in being more cautious and aware of entering transactions in which the Due on Sale Clause is a factor.

What has your experience been with the Due on Sale Clause? Let me know in the comments!

Regards,

Cameron Dunlap