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Latent Landmine #1: Due on Transfer Clauses
(This article is NOT legal advice. Consult an attorney for any specific legal issues you may have.)
I’ve created my “Latent Landmine” series to highlight items that are often unnoticed, and may not affect some people; but nonetheless could cause misery to others if they run afoul of them. Caveat Emptor, “Buyer Beware” is alive and well today as it’s ever been. However, the way to fight this is by building on the concept that “knowledge is power”. Hopefully, if all goes well, my series will help someone identify a potential problem, if not avoid it altogether…that’s the goal anyway.
OK, I got busy with other legal stuff, so this follow-up post took longer than expected. Nonetheless, the results are finally in!! Drum roll, please…
Based on the comments from my earlier post, due on transfer clauses are one of a variety of “anti-alienation clauses” used virtually all the time in new loans (thank you, Elizabeth!! J). However, since due on transfer clauses are only one member in this group; about all I feel comfortable saying is that due on transfer clauses are “frequently” used in new loans (not a really accurate term, I know; but there you have it).
At the risk of stating what may seem obvious, due on transfer clauses are a mechanism to help a lender preserve their rights in the collateral (real estate) of the borrower. In this case, if the real estate is subsequently transferred in violation of these terms, the lender can call the unpaid balance due. If the amount called due isn’t paid, then the lender can foreclose on the property.
The problem created here, is that due on transfer clauses are very broad in scope…they can limit, impair, or possibly completely preclude subsequent activity/utilization of the collateral. Even seemingly “innocent” subsequent transfers of the collateral, even transfers that don’t really interfere with the lender’s rights in the collateral, may be barred. For example, how many people have done any of these things: (1) Transferred mortgage property into a trust (e.g. living trust, land trust, etc.); (2) Transferred mortgage property into a business entity, such as an LLC or corporation; or (3) Transferred mortgage property between spouses as part of a property settlement agreement in a divorce? Did you review the terms of your mortgage BEFORE you subsequently transferred your mortgaged property? If you didn’t, that’s very risky behavior.
These anti-alienation clauses, of which a due on transfer clause is a member, are “creatures of contract”. Meaning you have to read the express terms of the promissory note and deed of trust (or mortgage if you have a true “mortgage”) to determine what you have/don’t have. Hopefully, even if you have a due on transfer clause, you at least have some form of “savings” provision to take out some of the draconian results that might otherwise occur, such as a requirement that you’re to contact the lender for their approval before you subsequently transfer the property.
Personally, I don’t have problems with anti-alienation clauses as a whole. I’m fine with lenders preserving their legitimate interests in the collateral of their loans. However, in my experience, these due on transfer clauses cast too broad a net, and frequently capture both the good with the bad, which isn’t a good thing. I think a more narrowly tailored anti-alienation clause, such as a due on sale clause, is better at allowing those “innocent” subsequent transfers of the collateral, such as those I listed above, while still preserving the lender’s rights in the collateral.
Another “legal-ease” reasoning for my basic dislike of due on transfer clauses, goes to the nature of the lender’s rights in the collateral. Namely, WA is a lien-theory state, not a title-theory state (as other states are); as far as the nature of what a lender’s right in the collateral are concerned. In WA, a deed of trust or mortgage is only a “lien” against the true owner’s title; the lender does NOT “own” or “hold” title to the collateral. In this regard, I dislike the over-reaching aspect of a due on transfer clause since it can too easily preclude subsequent property transfers which may have no substantive or material affect on the lender’s rights in the collateral.
In summation, when considering a loan against your property, consider also reviewing the terms of your loan for anti-alienation clauses, particularly any due on transfer clauses that may impair your future use of your property. If there is a due on transfer clause that you know will impair your future use of your property; you’d better talk to you loan officer. Can you get it removed completely? If not, can you narrow the scope of the due on transfer clause; such as by changing it to a due on sale clause? Yes, I know, it’s just one more thing in a long list to look out for…ugh. Nonetheless, doing so could save you trouble down the road.
Posted: June 11th, 2007 under Legal Issues.
Tags: clauses, due-on-transfer, legal, real-estate
Comments
2.
Comment
from ARDELL
Time June 12, 2007 at 9:29 am
I’m with Craig on this one. Could be because I worked at a Bank for so many years. But clearly the lender is entitled to a complete and uninterrupted trail to the original property owner/borrower and the collateral throughout the term of the loan.
Even in the event of divorce, if the husband was the primary wage earner at time of purchase, doesn’t seem fair to the lender if the property/collateral for the loan is transferred to the wife. I only saw the loan default once after this happened, and the lender did eventually get to sell the property in foreclosure. But it was very difficult for them, given the loan was not in the same name as the property at the time of the default.
3.
Comment
from Joe Beitey
Time June 12, 2007 at 12:46 pm
Hi Craig,
You’re right, “land trusts” seem to be sort of a ghost-like creature that doesn’t seem to formally exist; but I’ve seen Land Trust Agreements, as I’m sure you have. Compounding the problem is that many people use the term “land trust”, when they mean something else. Also, late night infomercials and some get rich quick real estate seminars push these things too (along with plenty of misinformation; but that’s another story).
The land trusts I’ve seen were simply a form of fully revocable, fully amendable, grantor trust, similar to a living trust used in estate planning. In my experience, the people setting them up were all motivated by the desire to remain anonymous in the land holdings as much as possible…an asset protection strategy (whether they were quickly flipping property, or holding it longer term varied with the person in my experience). If a person were dealing in debt-free real estate, I can see how a person may pick up some stealth; othewise, I question whether they’re worth the effort…hmmm, maybe that’s a subject for another post. 
As to your 2nd issue of whether mortgaged property subsequently transferred into a biz entity is “innocent” or not…I’m not ready to simply give the bank a pass on this.
Yes, you’re correct that formal forms of biz, like corp’s & LLC’s, are their own seperate legal entities, and can sue, be sued, file BR…even “marry”, “divorce” and have “kids” (ie. merge, divest & spin-off ), and transfers to these entities are a “new person” in the eyes of the bank. However, I don’t see where there is additional risk to the bank by having a borrower transfer mortgaged property into a fromal form of biz, like and LLC or corp; particularly if it’s a biz entity wholly owned by the borrower. If the loan isn’t repaid, simply foreclose…which the bank can already do w/out the due on transfer clause. In fact, in today’s litigation-oriented society there is a strong argument to be made that NOT putting your biz property into a formal form of biz, like an LLC or corp, is itself very risky/negligent, and banks should want this risk reduced by encouraging its biz customers to transfer their biz property into a formal form of biz. Thus, I believe the bank shouldn’t be using such broad anti-alienation terms in their loans that prevent this from happening. Furthermore, and this is what really gets my goat, I know there are instances in which the bank knows ahead of time the borrower will soon be transferring the property into something like a trust, LLC, etc, as part of other things the borrower is doing, and they still put a due on transfer clause into the loan for crying out loud!
As far as bankruptcy is concerned, I feel the banks (and other creditors) are already protected enough by the bankruptcy statutes which already have anit-fraud provisions in place to allow for such things as preferential transfers to be set aside by the BR Trustee.
I still think it’s good advice that if you know you’re going to be transferring your property sometime after getting your loan, check to make sure something like a due on transfer clause isn’t in your loan that’s going to prevent your anticipated property transfer…don’t risk a foreclosure to something like this…you need your property more than the bank does.
4.
Comment
from Joe Beitey
Time June 12, 2007 at 1:03 pm
Hi Ardell,
I answered some of what you’re talking about in my reply to Craig (please see my comments there). My big concern is with banks getting too broad in their limitations as to what borrowers can subsequently do with their property…it’s overreaching in my opinion.
As I said originally, I agree the bank has a right to preserve it’s rights in the collateral; but too often these due on transfer clauses cast too broad a net, and capture the good with the bad. The whole jist of my argument comes down to this: If the bank isn’t taking on any new risk by the subsequent transfer of property, it shouldn’t be limiting the transfer.
The bank, typically in 1st position on the property, can already foreclose if the loan defaults for non-payment. In many instances, having the loan default because of a subsequent transfer of property doesn’t harm the bank, and shouldn’t be precluded by the bank. In fact, the subsequent transfer of property may even benefit the bank to reduce risk to the borrower.
5.
Comment
from Chris Lengquist
Time June 12, 2007 at 2:32 pm
I guess I still maintain as long as the payments are there on time this is all moot. Maybe not from a legal standpoint. But from a practical one.
ie, if Joe takes over the mortgage from Jim, and rents the house out to whomever he pleases the mortgage company will never actually even know UNLESS Joe doesn’t make his payment by the perscribed time.
I’m not necessarily for this practice. I’m just point out it’s real life application. But I suspect you will be getting to that soon based on your comments on the first post.
6.
Comment
from Joe Beitey
Time June 12, 2007 at 3:39 pm
Hi Chris,
Your experience seems to be similar to mine. As a practical matter, the banks really don’t seem to care what happens with their collateral so long as the loan is paid on time.
However, this “turning a blind eye” attitude may not last forever. If interest rates continue to climb, as we’re told they are from several of our dedicated RCG bloggers, there is probably some tipping point at which the banks will begin policing up these other non-payment-based loan violations. I can easily imagine some jr. bank exec wanting to become a sr. bank exec, coming up with the idea to use these due on transfer violations (or some other non-payment based loan violation) as leverage over the borrower to force them into either refi’g the property at the higher rate, or face foreclosure.
The borrower is supposed to fully comply with all loan terms, including their anti-alienation terms if they have them. Hopefully our RCG readers will look before they leap when doing their real estate deals!
7.
Comment
from Ron Wose
Time August 18, 2007 at 3:28 pm
Hello Joe,
I blame the existing mortgage problems in California to the insertion of the fedral due on sale clause that the US Supreme court passed. Without the assumability of mortgages in a declining market like we are currently seeing, there is no way the lender can preserve their equity in their loans. When a great borrower with good credit has to move to Texas, he has no alternative in a declining market, but to file bankruptcy, Short sale, or Foreclosure, due to the fact that the loan is not readily transferable like they were in the 70’s and early 80’s. I have been trumpetting that horn for a long time, and every one is trying to solve the S& L dilemma of lost value to the lenders, but they hang on and will not let a willing and able borrower openly assume their loan products. By the Feds allowing loans to be assumable again, it would open and remove the quagmire of homes that cannot be sold, and would give the American people a free and moving real estate market that we deserve.
1. Comment from craig
Time June 12, 2007 at 8:13 am
Joe — a couple of comments. First, you reference a “land trust.” I’ve seen references to this type of entity previously, often in the context of a transaction involving a real estate investor who intends on immediately reselling the property. However, I have not been able to find any reference to a land trust in WA statutes or case law. What is your understanding of a “land trust” here in WA?
Second, I disagree that transfer of the property to a business entity is an “innocent” transfer that should not prohibited by an anti-alienation clause. A business entity is designed to eliminate an individual’s personal liability. The entity can sue and be sued, declare bankruptcy, etc. Thus transfer to an entity jeopardizes the bank’s collateral to the same extent as transfer to another individual, notwithstanding the fact that the owner may have the entire ownership interest in the entity. From the bank’s perspective, there is now another owner of the property.