Jump to content
The forums have been archived and are now read only. Years of great info saved for your reading pleasure. Thank you! Visit us on Facebook: https://www.facebook.com/NakedInvestor/ ×
The Naked Investor Forums
tgaspard

Disclosure and the Due on Sale Clause

Recommended Posts

What is the general opinion of people here, if it is necessary to disclose to the seller (when doing a lease/purchase) that the seller's loan 'may' be called back due to the DOS clause of their mortgage?

 

Should we be telling this to the seller when doing a lease purchase? (The probability is small of it ever being called back but it is still there)

Share this post


Link to post
Share on other sites

tg, I'm not the Legal Eagle here, but let me chime in with my opinion. Whether or not it has any legal validity will be determined when Mike P. comes by to reply.

I don't make a point of telling a homeowner that a lease or a lease purchase may cause the lender to call in the loan. Not to be deceitful, but because I have never seen it happen personally. It is such a remote possibility in my experience that I don't consider it when doing a deal. I also have my doubts as to whether or not a lender has the legal right to do so as a matter of routine procedure. Unless a mortgage has written into the agreement that leasing the property will make the loan due and payable immediately, I can't see why the DOS will kick in.

In the real world, (and that is where I sometimes like to reside :D ), if a lender is receiving their payment each month they are not interested in upsetting the cash cow that is that loan with those interest payments.

On the other hand, if a homeowner specifically asked me about the DOS, my reply would be to tell them to read the agreement and terms of their mortgage.

My two cents.....

Share this post


Link to post
Share on other sites

I'm no lawyer either but I have looked into this a bit.

 

The wording of the standard FNMA/FHLMC clause and pertinent regulations and laws is that the lender can call (make you pay off in full right now) the loan whenever you:

 

1) sell the property

2) lease the property for more than three years

3) lease the property for any length of time, if you also give the tenant an option to purchase it

4) sell the property via a land contract (that means the buyer gets everything but the deed)

5) transfer interest into a trust that owns the property

6) and so forth

 

You can click HERE to see where I got this information. This page also has a link to the text of the Garn-St. Germain Depository Institutions Act of 1982. This is the act that seems to have started the whole "due on sale" thingy.

 

So, it appears that the bank actually does have the power. But, unless rates go up drastically, it is doubtful they would ever actually "call" the loan due. Let's face it, banks don't really want to own real estate....they want to get their monthly interest payments. As a business, that's where their monthly cash flow comes from. If/when they call a loan due, their cashflow on that property stops until they get the house handled. In reality, calling the loan due creates a negative cashflow situation for them for whatever amount of time it takes to get the home sold and out of their inventory. Now, if they have a strong equity position in the property...say 80% LTV or less, then they may be willing to foreclose/call the loan. Each house really stands alone on its own merit. I feel that you need to think about these things before getting involved with any property.

 

I'm a little more risk averse. I disclose everything to the seller if I am buying subject-to, including the due sale clause. As a matter of fact, I make them sign a disclosure, stating that they fully understand the due on sale. That's why I only do a subject-to in a foreclosure situation. The sellers understand that the "due on sale" is really no worse than the foreclosure. They are looking at losing their house anyway, so my solution is still better.

 

Mike P., I'm interested in what you have to say about this topic.

Share this post


Link to post
Share on other sites

Friends,

 

I'm out-of-pocket for about a week. Will post my response when I return. An interesting issue I must say.

 

Chat with ya' then!

 

Mike P. :D

The Legal Eagle

Share this post


Link to post
Share on other sites

A couple of observations about the due on sale (DOS) clause issue.

 

When you read how other investors approach this issue, you get the range from “No problem” to “Big problem—and I hope you like Bruno, your new cell mate in federal prison.” And, of course, there are also the “finesse guys” who tell you: “There’s a problem, but here’s 25 ways to get ‘around’ the problem.” :o

 

Maybe we can step back a little here and get a better idea of what’s really involved.

 

For our purposes, let’s assume (without conceding—lawyers love to say that!) that the DOS clause is triggered by an option to purchase. What then?

 

One thing to consider is: If there is a duty to notify someone of the DOS issue, who has the duty, and to whom is it owed? Why is this important? Law students spend an entire year of their miserable lives studying a course called ‘Torts.” No, the course isn’t about pastry; it’s about civil wrongs that are not breaches of contracts. Much of that year of torts is spent learning how to play "Pin the tail on the liable party" using a "duty" analysis. Lawyers and judges just keep playing that game. In other words, "duty" is a concept deeply engrained in tort law.

 

Most folks seem to assume that if there is a duty, it is the investor who owes the duty to the seller. Maybe they're wrong. Maybe it’s the seller who owes the duty (if any) to the lender holding the mortgage. After all, they entered into the contractual relationship with the lender and are in the best position to know what can and can’t be done and under the mortgage contract. Furthermore, it makes sense that the owner, who is already in a relationship with the lending institution, would be the proper party to notify the lender of any change in circumstance. Under this analysis the investor would not be obligated to mention the DOS issue to the seller, unless asked. :lol:

 

There is, however another way of looking at this (you knew this was coming, didn’t you?). Caution may be the order of the day.

 

A seller with a called loan is going to be as unhappy as a newly-minted former spouse, and may look for someone to sue. That someone would most likely be the investor who (in their mind) got them into this mess in the first place. The costs of defending such a law suit would be substantial, even if the investor won.

 

To make matters worse, if the investor lost in court, an LLC or other corporate business form may not protect his or her personal assets if fraud is shown by the seller. If that isn’t bad enough, I’m unaware of a malpractice insurance policy for investors that would pay for the costs of defense and any money judgments resulting from such law suits. :( If this point of view seems persuasive to you, then the question is how and when the investor should make the disclosure to the seller.

 

So there you have both sides. I’m not sure there’s any clear right or wrong answer here. It’s probably more a matter of what your personal risk tolerance is. Some folks are high-wire walkers, others like their feet firmly planted on the ground. ;)

 

Hope that helps,

 

Mike P. B)

The Legal Eagle

Share this post


Link to post
Share on other sites

Mike,

 

You stated:

 

A seller with a called loan is going to be as unhappy as a newly-minted former spouse, and may look for someone to sue. That someone would most likely be the investor who (in their mind) got them into this mess in the first place. The costs of defending such a law suit would be substantial, even if the investor won.

 

To make matters worse, if the investor lost in court, an LLC or other corporate business form may not protect his or her personal assets if fraud is shown by the seller. If that wasn’t bad enough, I’m unaware of a malpractice insurance policy for investors that would pay for the costs of defense and any money judgments resulting from such law suits.  If this point of view seems persuasive to you, then the question is how and when the investor should make the disclosure to the seller.

So, based on my previous statement, would you say I am doing my part to protect myself by getting the seller to sign a disclosure statement that says they understand there is a "due on sale" provision in their mortgage, and that what we are doing is violating that agreement? Im not looking for an absolute here, but in your opinion, would that help my case if, in fact the seller did try to sue me if the lender called the note?

 

I have found that sellers don't really care about the whole "due on sale" issue, or signing my disclosure document if it is a foreclosure situation. Heck, the lender is already calling the loan due, and exercising their right to take the asset. Sometimes the lender doesn't care either. I was negotiating a short sale once and the loss mitigation officer at the bank asked me point blank over the phone if I already had the deed? Of course I didn't know what to say and after a long silence he said "we are not willing to negotiate with you as a principal unless you already have the deed." You could have knocked me over with a feather. So, even the lenders are willing to overlook their own rules if they stand to get back a property that they have a poor position in.

 

But, now knowing that even a lease-purchase is technically considered a transfer of ownership makes me wonder if I should have everyone signing disclosures. I think it would scare off a seller on a lease-purchase deal. I know one local investor here that notifies the lender on every deal he puts under contract on a lease-purchase. He just tells them flat out that he is a property management company, the seller couldn't get the home sold, they didn't want the home to go into foreclosure, and that he will be making the payments to them on behalf of the seller until the house is re-sold. He's been doing it that way for 5 years and no lender has had a problem with it yet.

 

Like you said earlier, I think every investor has their own comfort level of risk and will operate accordingly.

Share this post


Link to post
Share on other sites

Greetings Mark,

 

You're definately on the "conservative" side of this issue in terms of covering your back side. You could probably do more to protect your assets by, for example, including an attorneys' fees clause in your agreements with sellers. If you did this then if you are sued and win in court, the other side pays your reasonable attorneys fees. In other words, you aren't stuck with the costs of defending when you're found to be not liable.

 

Your point about scaring off sellers is a real concern...this may be a real test of the investor's finess. Oh, and I don't think you are necessarily "violating" the DOS clause with a lease option, merely "triggering" it. Two ways of saying the same thing, but former sounds kind of scary, the latter less so. Sometimes style is everything!

 

BTW, although the article that you provided the hypertext link to in your previous post contains some good food for thought, I have serious problems with some of the material from a legal stand point.

 

Mike P. ;)

The Legal Eagle

Share this post


Link to post
Share on other sites
Law students spend an entire year of their miserable lives studying a course called ‘Torts.” No, the course isn’t about pastry;
An attorney with a sense of humor? What's next? A mother in law with a kind word for her son in law?
You could probably do more to protect your assets by, for example, including an attorneys' fees clause in your agreements with sellers. If you did this then if you are sued and win in court, the other side pays your reasonable attorneys fees.
I can't speak for others, but all my agreements and contracts include such a clause. Sometimes just such a clause will deter a homeowner on shaky footing from filing a nuisance lawsuit.

Share this post


Link to post
Share on other sites

Thanks for all the replies - great discussion!

 

I have one more question on this topic that I'd like considered. I understand that the same law states that a straight lease for more than 3 years would also trigger the DOS clause. But what if I leased a home for one year terms only. And I did this over 3 years. Is the DOS clause considered triggered? I've done this with my personal home about 5 years ago. I keep leasing it out on yearly terms. Is the DOS considered triggered? Or is it for leases longer than a 3 year term?

Share this post


Link to post
Share on other sites
Guest Guest

tg, the DOS clause would probably not be triggered if the lease term is for one year only, then renegotiated twice at the end of each year. This would be different form a situation where you have a three year lease that is "bitten off" a year at a time. In that scenario you would have, in substance, a three year lease that you're dressing up like a one year lease. Make sense?

 

Mike P. ;)

Share this post


Link to post
Share on other sites

tg, The above post was me, I just wasn't logged in at the time.

 

Mike P. ;)

The Legal Eagle

Share this post


Link to post
Share on other sites

Would not the seperate Purchase agreement still technically trigger the DOS?

 

Mike

:ph34r:

Share this post


Link to post
Share on other sites

Hi Mike,

 

If by that you mean a option contract separate from the lease (of any duration), you should assume that the DOS clause has been triggered. The question then becomes: What, if anything should the investor do in light of the triggering.

 

Regards,

 

Mike P. ;)

The Legal Eagle

Share this post


Link to post
Share on other sites
Would not the seperate Purchase agreement still technically trigger the DOS?

 

Mike

:ph34r:

Technically? Perhaps. Realistically and likely? Probably not. I mean, who watches these things? The REP's?*

 

 

 

 

 

 

 

 

 

 

 

*Real Estate Police

Share this post


Link to post
Share on other sites

×
×
  • Create New...