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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Feb 3, 2021

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Mortgage borrowers must notify their lenders when they decide to sell their home.

In fact, there is a legal clause that ensures borrowers follow this protocol. Almost all mortgage loan contracts have a “due on sale” clause which deals with the sale of the home.

The due on sale clause creates a legal obligation in which the borrower and homeowner must use the proceeds of the sale to repay their mortgage loan debts to the lenders. If the full repayment is not possible, they are expected to repay as much of the loan as possible.

The most common type of mortgage loan is a 30-year fixed rate. Most homeowners will move to another home in that time period. Since moving is a likelihood, lenders include this clause as a form of protection.

Mike Arman, retired mortgage broker, said there is no reason to not notify the lender. He said all mortgages written in the past 20 years have a due on sale clause.

“There are very, very few assumable mortgages leftover from the old days, and if the buyer wants any new financing, the new lender is going to insist on being in first position so the older loan has to be paid off in full before any new loan will close,” Arman said.

Jim Angleton, president of Aegis FinServ Corp., agrees with Arman. He said that 99.9 percent of all mortgages have a due on sale clause.

In the past, mortgages allowed possible assumptions of loans, but that is not the usual case.

“If the borrower plus closing agent ignore such terms found in the mortgage standards, they could be in violation of more laws than the mere sale assumption,” Angleton said.

Further Actions Required

Mortgage borrowers are required to get a payoff letter from the lender prior to selling the home, according to Craig Delsack, a NYC-based real estate lawyer. Since the mortgage is public record, the lender would see this in a title report and should insist the loan is repaid and have the mortgage released on or before closing the sale.

Without the payoff letter and the clause, the borrower could take the money and disappear, which leaves the new homeowner with the obligation to repay the mortgage. Delsack said it is a general rule that a home is sold with liens created by the seller, such as a warranty deed transfer, to prevent seller fraud.

Due on sale clauses are a stable part of the mortgage loan process. Delsack, who helped rewrite Fanny Mae’s loan documents years ago, said the clause is used because the lender has a lien on the house as collateral for repayment of the mortgage loan.

“To protect themselves from losing the collateral, the bank will require the loan paid off at closing,” he said.

Without this clause, the mortgage loan would be unsecured.

“The house is the largest asset a borrower has, so the bank does not want the seller to sell the collateral out from under them,” Delsack said.

There are, however, some exceptions pertaining to Federal Housing Administration (FHA) loans and VA loans. We’re exploring that now.

Small Exceptions

Besides older mortgages, there are a few instances for when the due on sale clause is not required when selling the home.

Steven Weisman, a lawyer and a scam and identity theft expert, said the only time this clause is absent is with FHA loans and VA loans. He said these two types of mortgages typically permit assumptions of the mortgage.

“An assumption of the mortgage cannot be done generally unless the lending bank agrees and in accordance with the terms that the lending bank requires including approval of the new buyer,” Weisman said.

If a mortgage loan is assumed, Weisman does not believe it is a good deal for the seller because they might have personal responsibility if the new buyer defaults on the loan.

Arman agrees. He said there are significant benefits to the due on sale clause.

“Do you want to make mortgage payments on someone else’s house?” he questioned.