Due On Sale – A Real Estate Attorney’s Perspective

BawldGuy Note: David Stejkowski is a well known Chicago real estate attorney with gobs of experience, hands on. Gobs, as in, closing $1 Billion in real estate transactions for clients. (He’ll correct me if I’m wrong.) The guy knows which way is north on the map. I’m so pleased to announce he’ll be a regular author from now on, posting roughly 2-4 times monthly as time permits. This, in the blogging community, is what we call a coup.

By David Stejkowski

If I only had a nickel for every time a friend, acquaintance or prospective client said to me, “What if I buy Blackacre subject to the existing mortgage and don’t tell the lender?” There’s no problem with that, right?

Wrong.

Why? It isn’t illegal, but it is a risky practice, and, being a risk-adverse lawyer and all that, one I cannot recommend.

I understand that there are good reasons for the buyer to do these deals. You can avoid underwriting the loan again, loan fees, costs, credit issues –- and you may want to preserve a dirt cheap deal. And for a seller I suppose it is a great albeit risky-laden way to get a deal done quickly.

Lenders –- at least when acting as they should — are in the business of: you guessed it, lending. To whom? Their clients, the ones they have vetted and decided were good credit risks and people who are likely to repay that loan. (Yes, character counts, sports fans.)

Lenders are not in the business of lending money to Joe Sixpack, only to have Joe’s evil step-nephew take over the deal and the payments, let alone a perfect stranger. And just about every single loan you’ll ever see has a “due on sale” clause attached to it. (Caveat: yeah, I have done loan transfers and assumptions in my career. But they are usually tricky and protracted deals.)

The due on sale clause is just that: if the property is sold or conveyed in any way (with some very limited exceptions – see here and the Garn-St. Germain Act for details), then the lender can proceed as follows – this being from the Illinois version of a Fannie/Freddie mortgage:

18. Transfer of the Property or a Beneficial Interest in Borrower. As used in this Section 18, “Interest in the Property” means any legal or beneficial interest in the Property, including, but not limited to, those beneficial interests transferred in a bond for deed, contract for deed, installment sales contract or escrow agreement, the intent of which is the transfer of title by Borrower at a future date to a purchaser.
If all or any part of the Property or any Interest in the Property is sold or transferred (or if Borrower is not a natural person and a beneficial interest in Borrower is sold or transferred) without Lender’s prior written consent, Lender may require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if such exercise is prohibited by Applicable Law.
If Lender exercises this option, Lender shall give Borrower notice of acceleration. The notice shall provide a period of not less than 30 days from the date the notice is given in accordance with Section 15 within which Borrower must pay all sums secured by this Security Instrument. If Borrower fails to pay these sums prior to the expiration of this period, Lender may invoke any remedies permitted by this Security Instrument without further notice or demand on Borrower.

What does that mean? The quick and dirty answer is this: if the property is sold the lender can call the loan and it has to be paid in full within 30 days. (And yes, this can include a transfer to an LLC owned by you. That is a whole different topic.)

Will the lender do so? Beats me. I am not a crystal ball guy; I’m just a dirt lawyer telling you the lay of the land. I have heard stories that loans are rarely called. But what if the interest rate is really low (as it is now)? Or something else comes up? The moral is that if you do this kind of deal as a buyer, be prepared to take out that “assumed” financing on short notice or be prepared to face the consequences. If you can sleep well at night with that knowledge, then God bless you. I can’t.

To make myself clear: it is not illegal to buy property subject to the existing mortgage. It is risky. But, that said, what if you conceal that fact to the lender? I am not a criminal lawyer but I think you’d have to start thinking about fraud, mail fraud, bank fraud, conspiracy and other kinds of laws. Taking a risk is one thing; committing a crime is entirely another.

By the way: If you are the seller, why in blazes would you do this? Can you say, “I’m still on the hook with the lender?” Good, I knew you could. You’d have to be really beyond desperate to want to take that risk in my opinion.

So, To Sum Up

1. Yes, you can buy and sell property subject to the existing mortgage.

2. If you do, you run the risk, however large or small in your business judgment, that the loan will be called. Be prepared. And if you are in a state with short foreclosure and redemption periods, be forewarned.

3. No, you can’t hide the fact that you did this deal from the lender. Well, not without even bigger risks, such as committing a crime.

David Stejkowski, a.k.a. The Dirt Lawyer, has a blog located here. His website is located here. David is currently licensed to practice only in the State of Illinois. If you have questions about state specific laws, please consult a local attorney. This post (and any comments) is not intended to confer specific legal advice, to create an attorney-client relationship or to provide advice about avoiding tax-related penalties under the Internal Revenue Code.

Related posts:

1. Hard Times? How ‘Bout A Little Perspective?
2. Real Estate Investment Loans – Will There Be a Lender Revolt?
3. What The Heck Is ‘DCR’ And Why Should Real Estate Investors Care?
4. How To Get Real Estate Flyin’ Off The Shelves Again — This Would Help Big Time
5. Taking Title ‘Subject To’ — A Caveat Or Two For Real Estate Investors — Don’t!