Whenever you borrow from a bank or other lender to purchase residential real estate or borrow against the equity, it is typical that there is a “due-on-sale” clause in your deed of trust or mortgage. This gives the lender the ability to require full payment on your note balance for the loan or foreclose on your residential real estate property if you made a transfer without the lender’s prior consent. Initially, borrowers were transferring to others who did not have as good of credit as the borrower which necessitated lenders protection of their loans by having the due-on-sale clause.

However, in the late 1970s and early 1980s when inflation was rampant, lenders became more aggressive (i.e., when borrowers added an additional owner or transferred their home into a living trust) so that the borrower would have to pay a higher interest rate on their loan payments. As a result, the Garn-St Germain Depository Institutions Act was passed by Congress and signed by President Reagan which prohibited lenders from enforcing their due-on-sale clause in nine different situations as follows:

  1. Creation of a subordinate lien (i.e., mortgage) to the lender’s lien as long as the borrower still has the right to occupy the property. So, you can have a second mortgage on your property without the initial lender calling your note or foreclosing on your property or renegotiating your interest rate.
  2. Creation of purchase money security interest for household appliances. For example, if you needed to borrow against the equity in your home to purchase a washer and dryer, the first lienholder (your initial lender) couldn’t foreclose on your home or require renegotiation.
  3. Transfer by devise, descent or operation of law. For example, if you inherit your parents’ home (by will, trust or intestacy) and it is subject to a deed of trust or mortgage, the lender can’t foreclose or require renegotiation of the interest rate (although you still have to make the note payments).
  4. Leases of less than three years (even if renewed).
  5. A transfer to a relative resulting from death of a borrower. For example, if borrower signs a life estate deed such as a Ladybird deed (enhanced life estate deed whereby you retain the right to live in your home, sell it, have another mortgage, lease it, etc.) that is subject to a deed of trust lien to avoid a Medicaid estate recovery (Medicaid has a right to claim for benefits advanced such as care costs and drugs), then the grantee of the deed (such as the child or children) would be entitled to own the property subject to what is owed on the homestead to the lender.
  6. Transfer to a relative during life. As an example, if the borrower gets remarried, he or she could add his or her spouse as an owner to the property (although it may not be recommended) without triggering the due-on-sale clause.
  7. Transfers due to divorce, legal separation agreements or court order. If the borrower gets divorced and the spouse of the borrower is entitled to the home by court order or agreement, then the lender can’t enforce the due-on-sale clause.
  8. Transfer into an inter-vivos trust (which is usually a revocable living trust but could sometimes be an irrevocable trust) in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property. If the borrower deeds the property (i.e., the homestead) into a revocable trust there is generally no issue since the borrower is the beneficiary of the trust including the principal of the trust. However, most irrevocable trusts do not provide that the borrower could also be the beneficiary of the principal – especially if the borrower plans to apply for long-term care Medicaid benefits (the rules prohibit eligibility if the one whose assets are used to establish the trust is also a beneficiary of the trust). However, by giving the borrower the right to occupy the property is considered a beneficial interest retained by the borrower and the due-on-sale clause would not be triggered. So, the right to occupy should also be included in a Medicaid Asset Protection Trust (or any irrevocable grantor trust if you do not want the lender to be able to call the note). If the borrower is not the beneficiary of the principal or income (which is often the case) of the trust and if the one who establishes the trust (in this the borrower) does not have the right to occupy the property, then the due-on-sale clause could be triggered.
  9. Any other transfers approved by the relevant federal agency.

Although banks are no longer as aggressive as they used to be in enforcing due-on-sale clauses, they may become more likely to review as interest rates rise due to inflation. The exceptions to the rule are often important when considering various estate planning options.

If interested in learning more about this article or other estate planning, Medicaid and public benefits planning, probate, etc., attend one of our free upcoming virtual or in person Estate Planning Essentials workshops by clicking here or calling 214-720-0102. We make it simple to attend and it is without obligation.