Overview:
In some instances, acquiring property “subject to” an existing low-interest loan can be legal and financially advantageous. However, this strategy carries significant risks and legal implications that must be carefully considered.
Most mortgage and trust deed agreements include a due-on-sale clause, also known as an alienation clause, which allows the lender to demand full repayment if ownership is transferred. If the loan documents lack this clause, the loan may be assumable, allowing the buyer to take over payments without triggering acceleration.
If a lender discovers an undisclosed transfer, they may call the loan due, potentially placing the new owner in financial jeopardy. Legal counsel is essential before proceeding with such transactions.
Real-Life Example:
A borrower acquires a single-family home “subject to” an existing first lien loan. The title transfers, but the original loan remains in the seller’s name. The lender was not notified. This arrangement can be risky, especially if the loan documents contain due-on-sale or due-on-encumbrance clauses.
A mortgage broker explains:
“My clients want to borrow against their property with a second trust deed. They acquired the property five years ago, subject to an existing loan. The original borrower is still listed on the recorded trust deed, and the property has appreciated significantly.”
A knowledgeable lender responds:
“The first trust deed includes due-on-sale and due-on-encumbrance clauses. Since the lender wasn’t notified of the ownership transfer, they may view this as intentional deception and could accelerate the loan.”
As interest rates rise, lenders may be incentivized to call low-interest loans due to reallocating capital at higher rates. This could lead to default and foreclosure.
Legal Framework:
The Garn-St. Germain Depository Institutions Act of 1982 (12 U.S. Code § 1701j-3) limits when lenders can enforce due-on-sale clauses. Exceptions include:
- Transfers to a spouse or children
- Transfers due to death
- Transfers to a trust where the borrower remains the beneficiary
These exceptions primarily apply to residential properties with 1–4 units. For other property types, lenders retain broad rights to enforce due-on-sale provisions.
Lender Due Diligence:
Before issuing a second loan, private lenders and brokers must:
- Review the promissory note, deed of trust, and loan agreement
- Confirm the presence of due-on-sale clauses
- Obtain a beneficiary statement or recent payment history
Many private lenders will avoid second-position loans in these scenarios due to the risk of acceleration by the first lienholder. Others may proceed with full awareness of the legal exposure.