Enforceability (or lack thereof) of Due-on-Sale and Due-on-Encumbrance Clauses

Due-on-Sale Clause

The Due-on-Sale clause contained in most mortgages provides that if the property secured by the mortgage is sold to a third party without the lender's consent, the lender has the right to demand full payment of the loan. Lenders require this so that any prospective purchaser will feel compelled to submit a complete application to them, in order to avoid the risk of a foreclosure based upon the default of failing to obtain the lender’s consent. The application will contain the purchaser’s employment, income and all other information the lender would obtain if the purchaser was applying for a new loan. If the bank is satisfied with the creditworthiness of the purchaser, they will consent to the sale.

Due-on-Encumbrance Clause

A Due-on-Encumbrance clause is similar in that it requires the lender’s consent to be obtained prior to any further encumbrance of the property (ex - junior mortgages, etc). Lenders require this to prevent the borrower from incurring additional debts which would impair his/her ability to pay the lender’s mortgage loan.

Enforceability

The Garn-St. Germain Depository Institutions Act (12 U.S.C. § 1701j-3), however, provides that ALL Due-on-Encumbrance clauses are unenforceable with respect to mortgages secured by residential real estate of one- to four-family dwellings. This means that as long as you're dealing with a one- to four-family residence, including co-ops, you can completely ignore the provision in the mortgage that prohibits the further encumbrance of the property!

Garn-St. Germain also provides that certain Due-on-Sale clauses are also unenforceable. While most Due-on-Sale clauses are valid and enforceable, Garn-St. Germain prohibits the enforcement of the Due-on-Sale clause in many intra-family transactions involving residential one- to four-family residences, such as:

  • transfer to a spouse or children of the borrower;
  • transfer to a relative resulting from the death of the borrower;
  • transfer as a result of the death of a joint tenant or tenant by the entirety;
  • transfer into a trust where the borrower is the beneficiary, that doesn't relate to a transfer of rights of occupancy.

Although many lenders and attorneys may not be aware of the provisions of Garn-St. Germain, once it is brought to their attention, they are not likely to attempt to enforce them as doing so would violate the Fair Debt Collection Practices Act (FDCPA) and subject them to the liability provided by it (See my article on Fair Debt Collection Practices Act) (FDCPA).