The Effect of Due on Sale Clauses on Wrap, Assumption and Subject To Transactions

Wrap around, assumption, and subject to transactions are all methods of transferring property where an underlying lien (usually a first mortgage) is not extinguished contemporaneous with the closing. These types of transactions have been common in Texas for some time but have gained even more popularity in recent years due to increased regulation of alternatives like contracts for deed.

Since these transactions involve the transfer of the property without the underlying deed of trust being released, it is prudent to examine clauses in the first lien deed of trust concerning transfer of the property. These clauses are commonly referred to as due on sale clauses. While there is much fear concerning the effect of these clauses, most due on sale clauses do not pose an obstacle to wrap around, assumption, or subject to transactions.

The below is a common due on sale clause taken from a Fannie Mae or Freddie Mac uniform deed of trust:

"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 [emphasis added] require immediate payment in full of all sums secured by this Security Instrument."

Note that "may" has been emphasized in the above quote to highlight that the acceleration of the note is permissive or at the option of the lender. Furthermore, this is an option that the lender almost never exercises, and in an informal survey of hundreds of real estate lawyers, very few could recall any times when a lender had called an otherwise performing note due.

However, it is critical to remember that not all deeds of trust are Fannie Mae or Freddie Mac forms. Let us examine the due on sale clause in an FHA form deed of trust.

"Lender shall [emphasis added], if permitted by applicable law (including Section 341 (d) of the Garn-St. Germain Depository institution Act of 1982 12 U.S.C 1701j-3(d)), and with the prior approval of the Secretary, require immediate payment in full of all sums secured by this Security Instrument if: (i) All or part of Property, or a beneficial interest in a trust owning all or part of the Property, is sold or otherwise transferred (other than by devise or descent), and (ii) The Property is not occupied by the purchaser or grantee as his or her principal residence, or the purchaser or grantee does so occupy the Property but his or her credit has not been approved in accordance with the requirements of the Secretary."

Note that "shall" has been emphasized in the FHA due on sale clause to emphasize that the acceleration is mandatory by the lender as opposed to optional or permissive. Even though the lender would still need to take various steps to accelerate the loan, any transfer of the underlying property seems to put the borrower in an immediate default situation. As such, it would be less prudent to transfer a property encumbered by an FHA deed of trust.

Regardless of the type of deed of trust used, a deed of trust is generally a private contract where obligations run from the borrower to the lender. A violation of a private contract is considered a breach of contract and not illegal--it is a civil matter to be resolved. As one Houston area real estate attorney said, "There is no due on sale jail." Transferring property subject to prior liens can be complex, and it is important to use a competent real estate attorney when owner financing property or otherwise transferring property subject to prior liens.

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