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Due-on-Sale Clause – Understanding Land Trusts

This article is Part 3 of a four-part series on Land Trusts.  You can find Part 1 here: Understanding Land Trusts

Now you may be asking — how is the land trust going to help me with my lender?

The answer lies in why the land trust was created, and why it’s perfectly legal. It’s basically a compromise between two opposing forces.  On one side is the bank which is interested in generating income from loans and at the same time protecting itself through a security interest in real property — on the other side is the borrower (real property owner) who desires to transfer title to his property without fear of foreclosure or forced refinancing.  The bank acts as the protagonist by incorporating a “due-on-sale clause” into most, if not all, mortgages its writes.

The due-on-sale clause means essentially that the bank can decide to “call in” or “accelerate” its loan if the title of the property is ever transferred to another person or entity.  This is important to real estate investors who desire asset protection or freedom of contract.  If an investor wants to purchase property from a distressed seller subject to an existing mortgage, or to transfer his three properties into a limited liability company for asset protection, he does so at the risk that the lender discovers the transfers and subsequently accelerates the loans on the properties.  Many investors are troubled by this potential outcome and, thus, elect not to protect their encumbered investment real estate.

Now in reality, I’ve met thousands of investors at my workshops, and in all the years I’ve done them I’ve only heard of one or two instances where the bank used the due-on-sale clause to force a person to refinance their loan.  In these instances, the problem was simply that the owner was behind on his payments. But the due-on-sale clause has more ramifications than refinancing.

The bank’s decisions are influenced primarily by economic forces, so it doesn’t matter to them whether they are forcing you to refinance or not.  Furthermore, the bank is probably not going to hold on to your mortgage.  In the typical scenario, the bank will sell and resell mortgages to other banks as they need to.  Of course, they won’t allow homeowners to buy residences in entities or agree to the sale of real estate subject to an existing mortgage without first paying the mortgage in full.  Why?  Because if the bank attempts to sell the mortgage, a purchaser is not going to be willing to pay top dollar if they have to investigate who owns the property or the owners’ credit rating.  If the homeowner is forced to use his own name, then the bank and the potential purchaser of the mortgage have no problem doing business, since all the information is right there.

But from the homeowner’s perspective, this is horrifying — and rightfully so. Not only is the homeowner forced to borrow money from a faceless lending corporation, but he has no control over whom they sell the deed to, and who might enforce that due-on-sale clause. Even worse than that, he can’t protect himself in terms of liability by purchasing his real estate investment with a limited liability entity, because most commercial lending institutions refuse to do business with entities unless the buyer agrees to pay commercial interest rates.

This nightmarish scenario is averted with the Garn St. Germain Act. This 1982 legislation had many goals, including making home mortgages available to a large number of people. The Garn St. Germain Act addresses the basic conflict between homeowners looking to protect their assets, and the bank’s insistence that the homeowner buy the property in their own name. The Garn St. Germain Act prevents lenders from enforcing the due-on-sale clause when residential properties are transferred into a revocable trust and there is no change to the rights of occupancy. The key word here is revocable. Remember that a land trust is a revocable grantor trust that, as such, is covered under the Act.

Thus, under the Garn St. Germain Act an investor can create a land trust to hold title to his rental real estate without fear of his lender calling the mortgage due and payable.  Once the property is held by the land trust, an investor has the flexibility to assign his beneficial interest to a limited liability company or another purchaser without alerting any third parties to the fact there has been a transfer.  There are limits to the Garn St. Germaine Act.  If you have a property with more than four housing units, or have a loan that is not federally backed, then the Garn St. Germain Act does not apply.

– – –

In part 4 of this series on Understanding Land Trusts we will complete the discussion by explaining the privacy of ownership, avoiding county transfer taxes, and wholesaling property or purchasing property “subject-to” an existing loan.

  1. Comment by Linda Chea
    April 2nd at 11:15 am 

    I like this post very interesting. I believed you and have used the attorney that you have referred us to. We have transferred all of our properties into land trust and LLC. Now I am praying that the lenders will agree to have peace with us. I had talked to another attorney that had experience with RE taxes and LLC as well. He had negative thought about what we are doing and he wanted us to change what we are doing into an LLC and then a trust. He said we are doing it backwards. I had told Matt about this, but Matt believed what he was doing. I guess I have to wait and see who is right?

  2. Comment by Kimo Jarrett
    April 2nd at 1:49 pm 

    Isn’t it better to have the property put into the trust and then create an LLC with title changed while it’s in trust to avoid the possibility of the “due on sale clause” and take advantage of the Garn St. Germaine Act?

  3. Comment by Cindi
    April 2nd at 1:59 pm 

    This was a very interesting post. I have never seen that this requirement only applies to federally backed loans. How does one know if they have a federally backed loan? I have a Wells Fargo Home Loan. Are those all federally backed?

  4. Comment by Audie J. Clark
    April 2nd at 2:07 pm 

    The article mentioned that an investor can create a land trust to hold title to his rental real estate without fear of his lender calling the mortgage due. The Garn St. Germain Act prevents lenders from enforcing the due-on-sale clause when residential properties are transferred into a revocable trust, and there is no change to the rights of occupancy.

    My wife and I own property in Texas that is not a federally-backed loan. We have decided to lease it as rental property. My question is as long as we do not transfer the property, the lenders can not enfore the due-to-sale clause, correct? I need clarification please.

  5. Comment by Marco Santarelli
    April 3rd at 2:22 pm 

    Kimo — Timing of the entity creation is not relevant. To avoid the due on sale clause one must merely transfer the encumbered property into a land trust then assign the land trust to an LLC. Whether the LLC is in existence at the time the land trust is established or afterward will have no bearing on this transaction.

  6. Comment by Marco Santarelli
    April 3rd at 2:23 pm 

    Audie — Correct but why take a chance and keep the property in you own name. I find lenders (regardless of whether the loan is federally backed) do not concern themselves over transfers into trusts. I would make the transfer and protect my assets versus leaving it in my own name and remaining exposed.

  7. Comment by Marco Santarelli
    April 3rd at 2:25 pm 

    Cindi — If you have a Wells Fargo loan, then chances are about 100% that it’s federally backed. Very few banks ever keep the mortgage loans in house. They sell them off to the secondary market.

  8. Comment by Gabrielle
    April 6th at 4:53 pm 

    I have a few questions please.

    Can one initiate a land trust when the property is currently involved in a legal proceeding of foreclosure?

    If a investment property deed currently sits in a sole member LLC, and the sole member is involved in a personal, voluntary chap 13 bankruptcy, can one transfer the property from that LLC into a land trust, and it will have the effect of keeping it out of the personal bankruptcy estate of the debtor, or would it have the effect of freaking them out and thinking you were trying to conceal assets?

    Does the investor who creates the land trust and transfers a property into it, retain the rights to speak on behalf of the land trust in a legal proceeding, or do they require the trust use an attorney to speak on their behalf?

    Thank you.

  9. Comment by Marco Santarelli
    April 10th at 1:38 pm 


    You can transfer title to a property that is in the foreclosure process, however, that does not protect the current owner or stop the foreclosure.

    A similar situation applies with a personally bankruptcy but you are required to disclose all transactions as well as those over the past 6-12 months. Trying to move or hide assets when filing a bankruptcy can be considered fraud and can face criminal charges by the courts. Everything must be disclosed by federal law.

    The creator or beneficiary of a trust can speak for the trust even if they are not the trustee, but that’s one of the reasons you have a trustee.

  10. Comment by Gabrielle
    April 10th at 3:17 pm 

    Thank you. Looking forward to reading your last part in the series.

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