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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Aug 3, 2021

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To be clear, you don’t have to notify your lender when you list your home for sale, but they are notified when you sell. You have an obligation to let them know and payoff the loan at the time of the sale. Prior to the closing of the sale, your title company will also request payoffs and send a wire when the loan has been funded.

In some cases, sellers will offer “seller-funded” purchases. If you have a mortgage loan lender, they have most likely written this into their contract. If you make the sale this way and they find out, they can call your loan due (meaning you have to pay off the entire amount).

As a precaution in many ways, mortgage lenders also typically have a “due on sale” clause. 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.

Are There Reasons Not to Payoff A Mortgage on Sale?

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 usually the case now. Lenders are naturally nervous about offering terms to a borrower they’re not familiar with. The solid business realities are that a borrower who would want to assume a current loan might not be as creditworthy as the original borrower and may not qualify for those terms on their own. This would present a greater risk to the lender.

“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.

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What Happens If A Seller Doesn’t Payoff The Mortgage?

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. Generally speaking, title & escrow companies will hold the money and disperse it to pay all associated parties including realtors, mortgage companies, sellers, etc.

If the seller were to somehow take the money without paying the mortgage off, it would leave 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.

Can A Buyer Assume My Mortgage?

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. Of course, this is something the lender generally checks off when you get the mortgage in the first place. They designate early on whether the loan can be assumed by another party. If so, they would also specify what requirements the new borrower would have to meet to make the transfer. The seller would also want to visit real estate law offices and retain a professional to represent their interests.

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.