Residential mortgages from banks always have a “due on sale” clause. It says that if you sell or transfer ownership of the property, the bank can “accelerate” the mortgage, calling the whole loan due. When they do that, it forces you to pay off the mortgage, refinance it, or face foreclosure. Banks are more interested in enforcing the “due on sale” clause when the existing mortgage has a low interest rate (e.g., 2 – 3%), but current interest rates applicable to a refinance are higher (e.g., 6 – 7%).
But what if that transfer is just part of life events, like inheriting property, settling a divorce, or an estate planning need to transfer your home to your revocable living trust? The federal law known as the Garn – St. Germain Depository Institutions Act (12 USC 1701j-3) (“the Act”) protects those borrowers from such financial harm.
The Act carves out 9 exceptions where lenders cannot enforce the due on sale clause on your residential mortgage as long as the payments are kept current. The most frequently used exceptions are:
(1) when the person who co-owns property with you as a joint tenant or as a tenancy by the entirety dies – e.g., you own mortgaged property with a right of survivorship together with your sibling or your spouse, and the other owner dies, leaving you as the sole owner;
(2) transfer to a relative resulting from the death of a borrower – e.g., you inherit from a relative’s will, trust, or under the intestate succession act where they died without a will or trust;
(3) a transfer where the spouse or children of the borrower become a full or part owner of the property – e.g., adding a child to your deed;
(4) transfer to the borrower’s spouse from separation or divorce; and
(5) transfer into a revocable living trust or irrevocable trust in which the borrower is a beneficiary and which does change the borrower’s right to occupy the property – e.g., to avoid probate, you set up your estate plan using a revocable living trust where, during your life, you are the beneficiary, and you put your home into the trust.
Notice three things that can be traps for the unwary:
(a) Transfers to an LLC are not protected, e.g., wanting to transfer your mortgaged home to a family LLC (instead of to a trust). Some lenders will voluntarily approve this kind of transfer if asked in advance, but it is not required.
(b) It protects only transfers made by the borrower. Subsequent transfers are not protected. For example, if you inherit mortgaged real estate from your parents, the lender cannot call your parents’ loan due as long as you make the payments. However, there is no protection if you then transfer the property to your own revocable living trust or transfer it to your child, because you are not the borrower. The lender could then call the loan due.
(c) It does not apply to commercial property, or to residential property with 5 or more units.
When a protected transfer happens, how should you handle it with the lender? First, keep payments current. Second, check the lender’s website for their process. Some lenders are easier to work with than others. The process typically involves submitting to the lender a letter or form describing the transfer, explaining why it qualifies as an exception under the Act, providing COPIES of relevant documents, and asking them to update their records to show the transfer recipient as the “successor in interest” on the loan. Relevant documents may be a death certificate, will, trust, deed to the trust, property settlement agreement, etc., depending on the circumstances. The downside is that the average lender customer service rep may not be familiar with the Act; they may even tell you that you are wrong (even when you are right). You may have to escalate your request to the right person to get it straight. Some transfer recipients choose to stay silent and fight that battle if and when it arises, but that can put more time pressure on getting a resolution. If your mortgage has escrow for taxes and insurance, another option before you make an estate planning transfer is to simply ask the lender to do away with escrow (meaning you will pay your taxes and insurance directly), and then proceed with the transfer. The odds of the lender learning of the transfer if you haven’t told them and if there is no escrow servicing agent are very low. The takeaway is that the bank lender is REQUIRED to honor a protected transfer as long as the mortgage payments are made, but there can be practical problems in dealing with the lender.
Kim K. Steffan is an attorney with Steffan & Associates, P.C. in Hillsborough. She can be reached at (919) 732-7300 or kim.steffan@steffanlaw.com.