One of the reasons I continue to churn out legal blogs is usually the process of writing the blog leads me to research new legal concepts. Often the knowledge I reap is immediately applied to a client’s situation. This past week I was writing a blog on living trusts. I’m not a fan of living trusts. Personally, I believe living trusts are used as a marketing tool that increases the cost of an estate plan, and offers no additional benefit to most clients in Pennsylvania.
Anyway, I stumbled upon 12 U.S. Section 1701j-3 & 12 CFR Section 591.5, a federal statute and regulation that carves out exceptions to the enforceability of due-on-sale clauses. A due-on-sale clause or acceleration clause is a clause in a loan or promissory note that stipulates that the full balance of the loan may be called due upon sale or transfer of ownership of property.
With the rise of interest rates in the 1970s, banks started to include these clauses in their mortgage contracts. There used to be a time when a homebuyer could assume an existing mortgage with the purchase of real estate. The interest rate on the old mortgage was often much lower than the interest rate on a new mortgage. Think 1980s with interest rates as high as 18%. Banks started to enforce the due-on-sale clauses forcing homebuyers to sign on to new mortgages with higher interest rates. The courts criticized these clauses as unreasonable restraints on trade. In response to the criticism, Congress passed the Gann-St. Germain Depository Institutions Act protecting commercial lenders and prohibiting state laws restricting due-on-sale clauses. But the Act also protects consumers and prevents lenders from foreclosing on a residential property with fewer than five dwelling units when the transfer or disposition of the property falls under one of the Acts’ limited exemptions. Several of these exemptions should be kept in mind as you prepare your estate plan or if you inherit property.
The first exemption involves a “transfer by devise, descent or operation of law on the death of a joint tenant or tenancy by tenants by the entirety.” 12 U.S.C.A. § 1701(j)-3(d)(3). Here, property can pass to you 1 of 3 ways without triggering the due-on-sale clause. So if you own property jointly as joint tenants with rights of survivorship or tenants by the entirety (married couples only), with any person whether a relative, friend, business partner or life partner, and that person dies, you inherit the property by operation of law (i.e., because of the way the property is titled rather than a clause in the person’s Last Will), the mortgage continues without adjustments to its terms or without acceleration of the loan. Likewise, if the property passes to you as a gift under another’s Last Will (‘by devise”) or by the intestate laws of a state (by “descent”), the mortgage also continues.
The second kind of exemption protects surviving spouses, children and other relatives from the enforcement of a due-on-sale clause upon transfer of the home. Often the survivor was unable to refinance the loan and was forced to sell the family home. Congress determined to relieve the survivor of the tremendous burden specifically prohibited lenders from using the due-on-sale clause against spouses, relatives and children of a deceased owner. The relative parts of the Garn-St. Germain Act are as follows:
- A transfer to a relative due to the death of the borrower. 12 U.S.C.A. § 1701(j)-3(d)(5).
- A transfer where the spouse or child(ren) becomes the owner of the property. 12 U.S.C.A. § 1701(j)-3(d)(6).
Congress also sought to protect transfers of the family home due to divorce where the property is transferred between spouses.
- A transfer resulting from a decree of dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement by which the spouse becomes an owner of the property. 12 U.S.C.A. § 1701(j)-3(d)(7).
Note the property transferred above under § 1701(j)-3(d)(5), (6) & (7) requires that the new owner occupy the property whereas a transfer that falls under § 1701(j)-3(d)(3) above does not. By exempting family members from having to make substantial payments upon the death of the borrower, these exceptions enable them to, in effect, assume the mortgage loan and allowing them to remain in the family home.
Another exemption that Congress included in Garn-St. Germain Act is a transfer by a homeowner into an inter vivos trust for estate planning purposes. Keep in mind that an inter vivos trust (i.e., living trust) is a trust established during the lifetime of the settlor rather than a testamentary trust that arises at death. The Act provides that you can transfer your property to a trust and not trigger a due-on-sale clause as long as you are a beneficiary of the trust and remain an occupant. 12 U.S.C.A. 1701(j)-3(d)(8).
So the Garn-St. Germain Act preempts due-on-sale clauses by preventing unauthorized lender enforcement due to death, divorce and transfers into an inter vivos trusts. If find yourself transferring property due to death, divorce or for estate planning purposes, keep in mind the following:
- The exemptions only apply to certain transfers,
- Some transfers require that the new owner occupy the property, and
- Only residential real property with fewer than five dwelling units can be transferred