Chapter: A property is being sold in New Hampshire with an existing mortgage. Which clause in the mortgage would allow the lender to demand immediate repayment of the entire loan balance if the property is sold? (EN)

Chapter: Alienation Clause (Due-on-Sale Clause)

This chapter explores the specific mortgage clause that allows a lender to demand immediate repayment of the outstanding loan balance if the mortgaged property is sold or transferred. This clause is known as the Alienation Clause, more commonly referred to as the “Due-on-Sale” clause.

1. Definition and Purpose of the Alienation Clause

• Definition: The Alienation Clause (or Due-on-Sale clause) is a provision in a mortgage contract stipulating that the full outstanding loan balance becomes immediately due and payable upon the sale or transfer of title of the mortgaged property. This includes outright sales, certain types of leases with purchase options, and sometimes even changes in ownership within a trust or limited liability company (LLC).

• Purpose: The primary purpose of the Alienation Clause is to protect the lender’s security interest in the property and their loan portfolio. Specifically, the clause achieves the following:

  • Maintaining Control Over Loan Risk: Lenders carefully evaluate the creditworthiness of borrowers before issuing a mortgage. The Alienation Clause prevents the original borrower from transferring the mortgage to a potentially less creditworthy individual or entity, thus controlling the lender’s risk exposure.
  • Interest Rate Management: During the term of a mortgage, interest rates fluctuate. If a mortgage were freely assumable (transferable), lenders would be locked into the initial interest rate for the duration of the loan, even if prevailing market rates increase. The Alienation Clause allows lenders to recalibrate their loan portfolio to reflect current market conditions by requiring the new buyer to obtain a new mortgage at the prevailing rate (or requiring the existing borrower to pay off the loan if a sale occurs). This contributes to the lender’s profitability and risk management.
  • Preventing Unapproved Assumptions: Without the Alienation Clause, borrowers might sell the property and allow the buyer to “assume” the existing mortgage. This effectively transfers the liability for the debt without the lender’s knowledge or approval. The lender loses control over who is responsible for the debt and the associated risk.

2. Legal Basis and Enforceability in New Hampshire

• General Enforceability: Alienation clauses are generally enforceable in New Hampshire and across the United States. The legal basis for their enforceability stems from the principle of freedom of contract. Courts typically uphold agreements voluntarily entered into by parties, including the provisions of a mortgage contract.

• Garn-St. Germain Depository Institutions Act of 1982: This federal law significantly impacts the enforceability of Due-on-Sale clauses. It generally preempts state laws that restrict their enforcement. While it validates the general enforceability of these clauses, it also outlines a few specific exceptions where a lender cannot enforce the clause.

• Exceptions to Enforceability (Garn-St. Germain Act): The Garn-St. Germain Act lists circumstances in which a lender cannot enforce a Due-on-Sale clause. These exceptions include:

  • Transfers to Surviving Joint Tenant: A transfer to a surviving joint tenant upon the death of a joint tenant.
  • Transfers to Relatives Due to Death: A transfer to a relative resulting from the death of a borrower.
  • Transfers to Spouse or Children: A transfer to a spouse or children.
  • Transfers Incident to Divorce or Separation: A transfer resulting from a decree of dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement.
  • Transfers into an Inter Vivos Trust: A transfer into an inter vivos (living) 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.
  • Second Mortgage Creation: The granting of a leasehold interest of three years or less not containing an option to purchase.

3. Practical Implications and Examples

• Sale Scenario: A homeowner in New Hampshire wishes to sell their property which is subject to a mortgage containing an Alienation Clause. The lender, upon learning of the impending sale, can invoke the clause and demand full repayment of the outstanding loan balance. The seller must then use the proceeds from the sale to satisfy the mortgage debt.

• Refinancing or New Mortgage: Typically, the buyer will need to obtain their own mortgage to purchase the property. The funds from the new mortgage are then used to pay off the seller’s existing mortgage. Alternatively, the seller could explore refinancing their existing mortgage before selling to improve the property’s attractiveness to buyers, though this would still trigger the due-on-sale clause upon the actual sale.

• Impact on Real Estate Transactions: The Alienation Clause is a standard part of most mortgage contracts and significantly impacts real estate transactions. Buyers and sellers must be aware of its existence and implications. Real estate professionals must also understand the clause to properly advise their clients.

4. Legal Considerations in New Hampshire

• Contract Law Principles: New Hampshire contract law governs the interpretation and enforcement of mortgage contracts, including the Alienation Clause. The terms of the mortgage must be clear and unambiguous.

• Notice Requirements: While not universally mandated, some jurisdictions or specific mortgage contracts might require the lender to provide notice to the borrower of their intent to enforce the Due-on-Sale clause. It’s crucial to review the specific mortgage document for any such notice requirements.

• Potential for Litigation: Disputes related to the Alienation Clause can arise, leading to litigation. These disputes often involve interpretations of the exceptions listed in the Garn-St. Germain Act or challenges to the validity of the mortgage contract itself.

5. Conclusion

The Alienation Clause (Due-on-Sale clause) is a critical element of mortgage contracts, providing lenders with the ability to protect their interests and manage risk. Its enforceability is generally upheld, subject to specific exceptions outlined in the Garn-St. Germain Act. Understanding this clause is essential for anyone involved in real estate transactions in New Hampshire and elsewhere.