Due On Sale Twist - Long - Posted by Ed Wachsman

Posted by Brad Crouch on November 10, 1998 at 03:43:29:


Tried to e-mail you, but your address doesn’t seem to be working. E-mail me as I have something to send you.


Due On Sale Twist - Long - Posted by Ed Wachsman

Posted by Ed Wachsman on November 04, 1998 at 05:37:34:

Ran into this situation last night and haven’t had a chance to think through it yet. Since others may encounter this from time to time I thought we could all benefit by brainstorming it.

The seller is in contract to purchase a new home and hasn’t been able to sell their current residence. It’s a skinny deal and only makes sense as a LO or subject to. I’ve read the mortgage and it doesn’t have specific due on sale language in the case of a lease (though a small case can be me made for it) but does have language requiring lender notification and approval for other transfers of interest.

For a variety of reasons, not the least of which is that I can foresee being out of pocket $5000 or more relatively quickly, I am leaning heavily towards a “subject to” deal so that I can be in title. The twist: the seller is already pre-approved with their current lender who has to see our purchase contract and settlement statement as part of their loan underwriting and due diligence. This is a new build in progress on a home they REALLY want (thus their willingness to take concessions on price and terms) and, due to some severe time constraints and concerns of the builder, a new loan application elsewhere really isn’t an option. They have to use the current mortgagee for their new loan.

I have done “subject to” deals, understand the normal minimal risks involved, understand and have used the ways to minimize the risks (trusts, etc.) but have never been in the situation where the mortgagee is, in effect, put on notice so blatantly. While I can see how this might (i.e., I’m sure the mortgagee would probably claim otherwise)lessen the risk by meeting the technical mortgage requirement of notification it certainly doesn’t meet the requirement for approval. I see a greater potential for this “notification” (i.e., the documents submitted for the underwriting process) to open a can of worms if the underwriter were to notify whoever is in charge of the transfer approval process (or whatever that process is called). My gut tells me they are unlikely to take that initiative but I haven’t any experience in this particular situation to really form any sort of intelligent opinion. (Some would say that holds true for most of my opinions! :slight_smile: )

The pertinent mortgage language is “If all or any part of the Property or any interest in it is sold or transferred (or if a beneficial interest in Borrower is sold or transferred and Borrower is not a natural person) without Lender’s prior written consent, Lender may, at its option, require immediate payment in full of all sums secured by this Security Instrument.”

What are your thoughts and ideas?

Re: Ed! Read the sentence before that verbiage!! - Posted by Bill Gatten

Posted by Bill Gatten on November 06, 1998 at 13:58:12:


What you have here is typical FHA servicer verbiage (we call it the drafting attorney’s dependence upon the reader’s “Cognitive Rigidity”). It’s a trick! If you will read the portion of the paragraph just before your quote, you’ll see that it clearly says: “Unless prohibited by applicable law, and with approval of the Secretary… THEN the lender could at its option…”

A lender’s taking exception to one’s doing the following IS INDEED PROHIBITED BY APPLICABLE LAW!

The fact is, that one’s placing a property into an intervivos, beneficiary directed, revocable trust, wherein the grantor is and remains a beneficiary (i.e., a Land Trust); and which does not entail a Request for Release of Liability or change in record data with the lender, IS entirely allowable
The law referred to here is the Federal Depository Institutions Regulations ACT of 1982 (the FDIRA, or Garn St-Germain Law), which provides that anyone can place their property into such a trust, whether the lender likes it or not. Following formation of the [land] trust and vesting to, say, a 3rd party trustee, a would-be “buyer” can then be made a co-beneficiary in the trust. Such appointment, though still not violating the due-on-sale clause (since it is transfer of personalty only), is none-the-less secret, private anonymous and unrecorded). Next, in order for the buyer to enjoy virtually 100% of the benefits of homeownership, including tax write-of, he need merely lease the property from the trust on a triple net basis for a prescribed number of years (up to 21 years, or the length of the underlying financing, whichever is greater [see IRS Sec. 163(h)4(D)).

Ed, in doing the above, the property never need be sold; nor is its title transferred beyond the [wholly allowable] trust.

One last point: Understand that Lease Options can and do, in fact, violate lender’s due-on-sale clauses. The Garn-St. Germain Law specifically declares that its protection does not apply to lease for more than three years, or one which contain a Purchase Options. It states that a lender (Federal, State or private) may in-fact call its loan due an payable if the security for the loan becomes the subject of any lease for more than three years, or which may contain an Option to Purchase. This is obviously because either event can be construed as a transfer of equity ownership in real property, entangling the lender in a real legal mess if it chose to foreclose for any other reason).

Bill Gatten

Thanks all. Great ideas! In appreciation… - Posted by Ed Wachsman

Posted by Ed Wachsman on November 05, 1998 at 03:18:48:

I will donate a portion of the profits from this deal to Habitat for Humanity.

Re: Due On Sale Twist - Long - Posted by Bud Branstetter

Posted by Bud Branstetter on November 04, 1998 at 12:36:10:


Here is a wild line of thinking for you. The money you would put down you can structure as a loan. Make it a home improvement if need be like in Texas. The loans terms would be favorable to the seller. No interest, no payments for 40 years. You would also have him sign a deed in lieu of foreclosure. If the due on sale Gestapo ever knock on your door you run out the back door and file the deed in lieu of at the courthouse. You now have the legal right to take over any non-assumable loan without the lenders permission.

Re: Due On Sale Twist - I can boogie to that. - Posted by karp

Posted by karp on November 04, 1998 at 09:33:10:

Okay here’s the “traditional” answer.
I would address the due on sale issue in a contract addendum in the first place stating that if the mortgagee elects to enforce the due on sale clause the new buyer will have 90 days to purchase the home through his own traditional financing. This way you are being very up fron twith the new mortgageee regarding what may happen.

This is the “loose cannnon” answer:
I would actually rewrite the entire contract and stick it into a obscure paragraph referencing such matters as I know for a fact that underwriters DO NOT read contracts line by line by line. They simply don’t have the time.
If it looks like a good egg and smells like a good egg- what the heck let’s call it a good egg.

And worse yet, here’s the “karp” answer:
Don’t hide it. But don’t make it known. This due on sale crap has gone way the heck too far. It is an abuse of Federal power and has no place in the lives of any homeowner much less the sophisticated investor. It is a non-issue and as such needs to be challenged in court an thus stricken from the coercive Federal Laws. Go ahead and throw it in their face, Ed. Stand up and take a bullet for what is right. I will organize the legal defense fund for your necessary bail monies to extract you from the “due on sale jail” and will also start a campaign fund for legislative homeowner rights reform. Imagine buying a car that you make the payments on, that you keep insured and yet the manufacturer tells you you can’t let your daughter drive it.

Thank god I am a libertarian…

aka Karl Hartley

“Hello, my name is Karl and I am a due on sale violator…”

Re: Due On Sale Twist - Long - Posted by JPiper

Posted by JPiper on November 04, 1998 at 09:23:12:

Hi Ed:

I would execute a lease/option. It doesn’t appear to me that this violates the due on sale clause that you cite. I would make the lease adequate for your seller’s qualification purposes.

As a part of the lease option I would have certain other documents executed. I would have a warranty deed executed by the seller. I would also have them execute a performance mortgage/deed of trust. Finally I would have payments handled by a third party escrow, who would make payment to the lender.

I would not record the performance mortgage or a memorandum of option unless I decided to maintain the lease/option. They would be there just in case. Rather after loan approval and after the deal closed I would exercise my option and take over the loan subject to if that is your preference.

Just to point out. In my opinion, if you have done the above, and record the performance 2nd, the deal would not carry significant risk in terms of “deed problems”, inasmuch as you have a recorded interest that is foreclosable if the seller defaults. (I don’t know your foreclosure laws and what risks might be present there.) To me, one potential difference might be from a tax standpoint, which you might want to explore. The other significant difference is that the risk characteristics for you would be different than you would experience with a subject to assumption and a deed. What I mean here is that if you wrote your lease as a series of one year leases which are renewable, the maximum period that you would be exposed for is one year. This limited exposure could be an advantage under certain scenarios.


Re: Ed! Read the sentence before that verbiage!! - Posted by JohnBoy

Posted by JohnBoy on November 09, 1998 at 02:29:10:

What about a seperate lease with a seperate option to purchase that is not allowed to be recorded? A seperate lease thats less than 3 years would not violate a due on sale clause. But what about the seperate option agreement? If its not recorded how would a lender ever know about it?

Re: Due On Sale Twist - Long - Posted by Alex Gurevich, TX

Posted by Alex Gurevich, TX on November 04, 1998 at 23:49:28:

This one went by me too fast. I thought one has to be at least in default under the terms of corresponding Deed of Trust to warrant a deed in lieu. If the loan has no payments and no interest, what would the grounds be for giving a deed in lieu ?

1-st lienholder calling the loan due named as default under the terms on the 2nd ?

Please clarify.

The “Friendly Foreclosure” - Posted by John Behle

Posted by John Behle on November 04, 1998 at 14:46:59:

The technique Bud describes can work well. We’ve used the “friendly foreclosure” and at times marched right in to the lender to tell them we are there to assume the loan.

A “junior lienholder” that forecloses to protect their interests is exempted from the due on sale provisions based on many years of court rulings and specifically mentioned and exempted through the “Garn - St.Germain bill” that put teeth back into the “Due on sale” clause after the courts had been over ruling it.

Ah, the wonderful bill meant to save the Savings and Loans. Again, ignorant legistators stick their nose into things they have no idea about. Similar to the Tax Reform act of 86 that destroyed sections of the real estate industry and sent us into a recession. They were very forcefully warned about the consequences by the National Association of Realtors, but they didn’t care.

Anyway, the technique has worked, though some institutions don’t like it and a few may even try to fight it - yet there’s no great benefit to them fighting it.

Besides, Karp will organize a resistance movement and take them on if the lender troubles you over it :wink:

www.karpmeister.com - Posted by Redline

Posted by Redline on November 05, 1998 at 12:31:04:

Karp, u r a k00l d00d!!

No seriously, some great advice put the way I can relate to it! Everyone … REVOLT! Let’s all go and assume mortgages and run to the bank branch and LAUGH RIGHT IN THEIR FACES!!!


Throw in a fruitcake every Xmas and it’s a deal! - Posted by Ed Wachsman

Posted by Ed Wachsman on November 05, 1998 at 03:32:20:

This site has helped me a lot. I think taking a bullet for the good of my fellow investors/site contributors is certainly a very modest and reasonable request and well worth the contribution to their welfare. As I am basking in the luxury of Club Fed, it will be nice to have those candied cherries to look forward to - annual reminders that someone remembers and cares. :slight_smile:

Re: Due On Sale Twist - Long - Posted by Bill Gatten

Posted by Bill Gatten on November 06, 1998 at 15:32:52:


Not that they are necessarily lying in wait to jump on you, but you might note that any lease beyond 3 years, or one containing any Option to Purchase is justification for a lender’s enforcement of its alienation provisions: i.e., a due-on-sale violation(FDIRA 1982).



Two documents - Two people - Posted by John Behle

Posted by John Behle on November 10, 1998 at 01:46:41:

Giving an option does not violate a due on sale. Leasing the property does not violate a due on sale. A lease of less than three years with a perpetual rollover clause goes to the “buyer”. Take $50, create a corporation or trust (land trust or business trust) and give the option to them (controlled by the buyer).

Record the option.

Re: Ed! Read the sent- the DOS not the problem - Posted by Bill Gatten

Posted by Bill Gatten on November 09, 1998 at 15:40:55:


There is no need for a 2nd lease and option. If you?re not going to record it anyway, it doesn’t matter. And remember… whether the lender knows about it or not is a moot point. The real point is: If you don’t record it, the optionee has no protection (e.g., against the Optionor’s optioning to someone else, selling the house out from under him, running up its debt, etc.), and he cannot take the tax write-off (See W.D. Belden Vs. US Tax Court, 70 TCM 274, Dec. 50,802(M))). If you do record it, however, you are then not only violating the due-on-sale clause, but you’re announcing to the world that the property is ripe for lawsuits, liens, judgements, seizures - re. BOTH the optionor and the optionee.

Further potential problems – if the resident defaults and refuses to comply with an order to vacate, the optionor may have to resort to Judicial Foreclosure, Ejectment Action and a Quiet Title action to posture the property for sale (while the tenant lives in the property rent-free for the duration of the legal melee).
From both parties’ points of view, they would all be better off and far better (if not ?perfectly?) protected in a 3rd party land trust conveyance, wherein the would-be optionee would acquire interest in the owner?s trust as a co-beneficiary. After such acquisition, the co-beneficiary would lease the property (on a straight triple-net lease) from the trust. This gives both parties complete protection against any untoward acts of the other; it protects the property from litigation; it give the tenant 100% of all tax deduction and all the myriad other incidents and benefits of homeownership. And all of this without danger, risk or the need for tricks, gimmicks and subterfuge. Period!

In such an arrangement, the resident co-beneficiary typically agrees that, upon termination of the trust, he/she will either: 1) sell the property, 2) refinance it in its own name, 3) extend the Agreement, or 4) return the property to the Grantor.


Actual loan created / defaulted - Posted by John Behle

Posted by John Behle on November 06, 1998 at 15:06:10:

When we’ve done the “Friendly Foreclosure” it has been where an actual second is created to match the amount of the downpayment, then it isn’t paid on. It is in default, though we do not file a notice of default.

We then approach the lender and make the arrangements to assume the loan. We’ve never had any trouble.

Re: Due On Sale Twist - Long - Posted by JPiper

Posted by JPiper on November 06, 1998 at 16:13:17:


I agree that in most modern DOS clauses that a lease/option would in all probability violate the due on sale clause.

However what Ed presented here was a clause that did not contain the typical language of the modern clauses that I have seen. Perhaps Ed left this language out, but it’s not clear to me that he did.

There was nothing in Ed’s post to indicate that this was an FHA loan, or even a loan via a Federally insured lender.

Based on that and the particular clause that he presented I know of no reason to assume that a lease/option would be in violation. As you know, ALL clauses don’t read the same way…which is why it’s important to read the clause. Greentree Financial as an example has a clause which would not prohibit lease/options in any manner.

However the thrust of Ed’s question had more to do with qualifying for a new loan with the same lender that currently held the existing mortgage. In light of this, one way to accomplish this would be to present a lease (I didn’t say it should exceed 3 years).

Another method would be with a trust, as you mention. By the way, I’ve enjoyed your postings regarding your methods with a trust. Good information.


Re: Ed! Read the sent- the DOS not the problem - Posted by Rob FL

Posted by Rob FL on November 09, 1998 at 16:47:04:


After reading several of your posts, I wondered if you could thoroughly explain this whole “co-beneficiary land trust” idea. Or do you have a website or somewhere else we could find out more.


Re: Due On Sale Twist - Long - Posted by Bill Gatten

Posted by Bill Gatten on November 07, 1998 at 21:44:55:


I must agree. We don’t really know what kind of loan Ed was up against (What was it Ed?); however, when I see that specific verbiage, I naturally presume it’s FHA. Most other agencies have more respect for our intelligence than to contrive such a blatantly misleading string of baloney: "Unless prohibited by applicable law…? It?s like someone saying, “Unless prohibited by applicable law, and with the prior approval of the Secretary, I have the absolute right to clang you on the head with a shovel… for any reason… if I choose to do so…”

The other one that yanks my chain is, "Beneficial interest in borrower, if borrower is not a natural person, may not be sold, transferred, hypothecated, folded, spindled or mutilated…? Dag nab it! The fact is that the BORROWER IS A NATURAL PERSON! Unless a corporation, partnership, joint venture, association, amalgamation, limited partnership, consortium, Kiwanas Club … or? If Bob and Sally Smith borrow money from any bank, as “Bob and Sally Smith,” they needn’t kow-tow to their lender to get approval to place their property into a trust or corporation, or to subsequently assign a beneficiary interest or sell stock! That’s their business, and Garn-St. Germain protects doing so. That’s why the third party land trust system works!

Re: Ed! Read the sent- the DOS not the problem - Posted by bill gatten

Posted by bill gatten on November 10, 1998 at 12:09:07:

www.cal-equity.com (don’t forget the hyphen or you get a mortgage company)