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An Exception to the Due on Sale Clause – Sale from Parent to Child Using An All-Inclusive or Wraparound Deed of Trust in California.

An all-inclusive deed of trust (“AITD”) is used when the seller will be financing part of the selling price, and the buyer will also take subject to the existing deed of trust. The seller remains on the existing loan (and continues to make the payments) and finances the difference between the existing loan balance and the purchase price. But any transfer normally triggers the “due on sale” or acceleration clause, where the lender may foreclose, calling the entire loan due. Once the deed is recorded, the transfer is public record, and the Lender may catch it. But there is an exception in Federal Law which blocks lender action for a transfer to the spouse or children of the borrower. This becomes important where the original loan has a low interest rate, or the buyer is unable to qualify for a loan.

Due-on-Sale-attorneyAll-inclusive deeds of trust are used when the interest rate on the existing loan is much lower than the current prevailing rate, the rate of the wraparound can be lower than the [prevailing rate, and the seller still earns a spread between the rate he is paying and the rate that the buyer is paying to the seller.

The exception is part of the Garn–St Germain Depository Institutions Act of 1982, that deregulated savings and loan associations and allowed banks to provide adjustable-rate mortgage loans. More importantly for us, it prohibits lenders from exercising the due on sale clause in transfers between parents and children. There are some other exemptions set out at the end of this Blog.

Wrap-mortgage-attorneyGiven that both parties play a significant role in the life of the transaction, there are many considerations to negotiate:

-There may be restrictions on Right of the Seller to refinance the underlying note.
-What is the obligation of the Seller to pay the underlying note in the event of acceleration of the underlying note due to: a. borrower’s default, b. acceleration because of the transfer?
-Should the Buyer pay to a collection agent to make sure the underlying note gets paid?
-Once the Seller’s equity is paid off, does he continue to collect the spread (the difference between the interest on the underlying note and the Buyer’s note) or is his note deemed paid?
-The Buyer should be able to pay the underlying note directly if the seller does not, and the Buyer can deduct these payments from the next installments of the AITD.
-If the Buyer defaults and Seller advances money to pay the underlying note, should the seller be able to add the payments (or the costs related to a non-payment default) to the balance of the all -inclusive note? The seller is entitled to interest on their cash advances.
-Any default under the terms underlying note, other than for non-payment, should also be a default of the overriding note that the Buyer can enforce.
-The manner of declaring default and conducting a foreclosure should be outlined in the AITD, to ensure support from title companies.
-If the underlying note contains a prepayment penalty, the AITD, should have at least the same. Regardless, if the Buyer prepays the Seller’s equity, so that only the balance of the underlying note remains, the Seller loses their interest override. If the Seller wants to maintain the yield, they will need a prepayment penalty in the AITD.
-When the unpaid balance on the AITD is the same as the principal balance due on the underlying note, will the Buyer be entitled to a reconveyance of the AITD?

-The AITD needs to mirror or better the terms in the underlying note:
Grace periods;
due on sale (acceleration) provisions;
timing of payment and amount of late charges ;
prepayment restrictions and penalties;
tax and insurance impounds;
insurance requirements and premiums;
leasing, condemnation, repair, and construction rights.

All-Inclusive-trust-deed-attorneyGarn -St. Germain Act: EXEMPTIONS to Due on Sale
(d) Exemption of specified transfers or dispositions

With respect to a real property loan secured by a lien on residential real property containing less than five dwelling units, including a lien on the stock allocated to a dwelling unit in a cooperative housing corporation, or on a residential manufactured home, a lender may not exercise its option pursuant to a due on sale clause uponC

(1) the creation of a lien or other encumbrance subordinate to the lender=s security instrument which does not relate to a transfer of rights of occupancy in the property;

(2) the creation of a purchase money security interest for household appliances;

(3) a transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety;

(4) the granting of a leasehold interest of three years or less not containing an option to purchase;

(5) a transfer to a relative resulting from the death of a borrower;

(6) a transfer where the spouse or children of the borrower become an owner of the property;

(7) a transfer resulting from a decree of a dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement, by which the spouse of the borrower becomes an owner of the property;

(8) a transfer into an inter vivos 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.