Alienation Clauses: What You Need To Know
Alienation clauses are commonly found in mortgage contracts. In fact, you’d be hard pressed to find a real estate loan that doesn’t include some variation of one. Ultimately, this clause allows mortgage lenders to charge a new buyer a higher interest rate, although there are exceptions under extenuating circumstances.
Let’s discuss what alienation clauses are and how they work.
What Is An Alienation Clause?
In real estate, an alienation clause, or due-on-sale clause, refers to contract language that requires the borrower to pay the full mortgage balance, as well as accrued interest, back to the lender before they can transfer the property to a new buyer. The alienation clause effectively spells out the terms in which the borrower is released from their contractual obligations in the case of a resale. The primary benefactor is the lender, because it prevents the borrower from transferring their mortgage terms to another buyer without the lender’s approval.
Alienation clauses are universal in today’s real estate market. If you happen upon a mortgage agreement that doesn’t include an alienation clause, you’ve found the rare assumable mortgage. An assumable mortgage allows a new owner, regardless of their credit history, to pick up mortgage payments, along with their (likely, better) interest rates, right where the previous owner left off.
It’s important to realize that just because a mortgage has an alienation clause doesn’t mean it’s triggered every time someone tries to assume a loan. In order to assume a loan with an alienation or due-on-sale clause, it has to meet the policies of the servicer of the loan as well as the mortgage investor who bought the loan from your original lender. If the loan was never sold, the policies of the lender apply.
The following policies apply if you want to assume a loan being serviced by Rocket Mortgage®:
- For conventional loans purchased by Fannie Mae or Freddie Mac, the loan needs to be an adjustable rate mortgage (ARM) that has had its initial fixed period pass.
- For Federal Housing Administration (FHA), United States Department of Agriculture (USDA) and Department of Veterans Affairs (VA) loans, the loan can either be fixed or an adjustable rate mortgage (ARM).
There are certain legal exceptions when the policies of the lender, servicer or investor in the loan are ignored for the purposes of assumption. Let’s get into those now.
Exceptions To Alienation Clause Enforcement
Alienation clauses became popular in the 1970s in conjunction with a rise in interest rates. In response to the changing market conditions, the U.S. Congress passed the Garn – St. Germain Depository Institutions Act of 1982, which allowed lenders to enforce alienation clauses, with some exceptions. Although never required to enforce an alienation clause, lenders are prohibited from enforcing the clause under the following conditions:
- Death: If the borrower dies and the deed is transferred to or inherited by a spouse (often, a co-borrower), child or relative who is already an occupant or plans to become an occupant
- Divorce: If a separation or divorce results in the borrower’s spouse becoming the property owner
- Transfer to a living trust: If the borrower transfers the property into a living trust while being the beneficiary and occupant
- Assumable mortgage: If the loan is missing an alienation clause, the new owner is not required to pay off the mortgage
- Second mortgage: It is illegal for the primary mortgage lender to demand a release of liability if a borrower takes out a second mortgage
How Alienation Clauses Work In Real Estate
After a borrower sells their property without notice to the lender the mortgage company may end up opening an account for the new buyer. The lender will evaluate the new buyer’s credit history, debt-to-income (DTI) ratio, the home’s market value and several other factors before extending a new mortgage with current interest rates. The lender will often handle the transfer of funds to pay off the borrower’s debt, close their account and return the profit.
Typically, it doesn’t happen this way. Usually, when a client is ready to sell their property, they would request an official payoff statement and the whole thing takes place in an orderly closing where the buyer has already secured financing for the purchase price and the seller uses the proceeds from the sale to pay off the mortgage.
Alienation clauses are typically short and sweet. Be sure that the language makes it clear that the amount due at sale will be the outstanding amount and nothing more. Borrowers are expected to pay the remaining balance and any late interest fees they’ve accrued, but never the interest that would have accrued over the life of the loan.
Alienation Clause Vs. Acceleration Clause
Acceleration and alienation clauses share one commonality: They both allow lenders to demand full, immediate repayment of debt at once, at their discretion. The acceleration clause, however, is the contract language that allows lenders to begin the foreclosure process, typically after a borrower misses at least two payments. Check your mortgage contract terms for clarity. Less often, loan acceleration can be triggered by a cancellation of homeowner’s insurance, failure to pay property taxes, a bankruptcy filing or unauthorized property transfer.
For homeowners, the experience of an alienation clause in action is often a celebration, while an accelerated foreclosure is a stressor.
The Bottom Line: Alienation Clauses Are In Place To Protect Lenders
In short, alienation clauses and acceleration clauses are standard provisions in nearly every mortgage contract. These clauses are meant to protect lenders, so it’s important for home buyers to understand these provisions before signing a mortgage contract.
We’re here to help you every step of the way. To learn more about alienation clauses, check out our guide. And if you’re ready to get started on your home buying journey, you can do so online with Rocket Mortgage® today.