Alienation clauses are in nearly every mortgage contract.
In fact, you’ll struggle to find a real estate loan that doesn’t include some type of alienation clause.
This clause dictates that a borrower must pay the mortgage in full before the property can be transferred to another person.
Read on to learn how this clause may impact your real estate transactions.
1. What is the alienation clause?
An alienation clause is a real estate agreement that requires a borrower to pay the remainder of their mortgage loan immediately upon the sale or transfer of property title — or before a new buyer can take ownership.
This clause, also known as a due-on-sales clause, is effective regardless of whether the transfer is voluntary or not.
It is standard in most mortgage agreements today.
The alienation clause is used as it ensures that you, the borrower, pay back the money the bank loaned you even when you go to sell or transfer ownership of your property.
It is a way to ensure that your lender’s interests are secure through the transaction.
That said, many lenders won’t actively enforce the due-on-sale clause in certain situations.
For example, borrowers may not need permission from their lender when they deed the property to their own trust or business.
Other situations will require permission.
Either way, it’s a good idea to check with your lender before making these decisions.
2. What are alienation clause terms?
Alienation clauses prevent assumable mortgage contracts from occurring.
It requires a mortgage lender to be repaid immediately should an owner transfer ownership rights or sell a collateral property.
These clauses apply to both residential and commercial mortgage borrowers.
If you aren’t bound by an alienation clause, then you (as the owner) are able to transfer the mortgage debt to a new owner in an assumable mortgage contract.
An assumable mortgage contract is one that allows a new owner to take over the previous owner’s remaining debt obligations, making the scheduled payments to the mortgage creditor under the same terms as the previous borrower.
Keep in mind, though, that assumable mortgage contracts are not common.
The alienation clause is there to allow mortgage lenders to structure contracts in a way that guarantees immediate repayment of debt obligations.
Thus, almost all mortgages have an alienation clause that will protect the lender from unpaid debt by the original borrower.
They can also protect the lender from a third-party credit risk, which could be associated with a new borrower taking on an assumable mortgage contract since the new borrower has a significantly different credit profile.
3. How does the alienation clause work?
Most mortgage contracts have an alienation clause.
If so, the full loan balance will be due as soon as the borrower completes a sale of the property or a transfer of the title.
When this occurs, the proceeds from the sale will first be used to pay off the loan before any money goes directly to the seller.
The seller cannot transfer the loan with its older interest rates and terms to the new buyer.
The buyer must apply for their own loan under current terms.
When a borrower sells their property without notice to their lender, the mortgage company may open an account for the new buyer.
The lender will then evaluate the new buyer’s credit history, debt-to-income (DTI) ratio, the property’s market value, and several other factors before they decide to extend a new mortgage with current interest rates.
The lender will often handle the transfer of funds to pay off the borrower’s debt, close their account, and return the profit.
However, it doesn’t always go this way.
More often, when a client is ready to sell their property, they request an official payoff statement.
Next, an orderly close occurs where the buyer has secured financing for the purchase price and the seller utilizes the proceeds from the sale to pay off the mortgage.
Alienation clauses are considered “short and sweet” (as long as the language is clear that the amount due at the sale will be the outstanding amount and nothing more).
Borrowers are expected to pay the remaining balance and any late interest fees they’ve accrued.
Yet, they do not have to pay the interest that would have accrued over the life of the loan.
4. What’s an example?
Here’s a basic example of when an alienation clause may be used.
When lenders choose to follow through with an alienation clause (it is optional), the lender must notify the property owner of their intent to accelerate the mortgage or speed up the repayment of the full loan amount.
As soon as the property owner becomes aware of the repayment acceleration, they have a minimum of 30 days from the date of notice to repay the full amount of the mortgage.
In most cases, an alienation clause is binding upon the property owner.
5. Why do lenders use the alienation clause in real estate?
Lenders use an alienation clause in real estate to prevent property owners from transferring a mortgage to a new person.
While you can sell your property before you pay off your mortgage, your alienation clause creates an obligation for you to use proceeds from the sale to pay down your mortgage.
The terms of your loan won’t have an impact on your buyer’s ability to finance a loan with similar terms.
If a buyer is not paying with cash, the buyer must work with the lender to come up with financing (interest rate and terms) that are applicable for their own financial and credit standings.
Alienation clauses are in effect for the entire life of a loan.
6. When did alienation clauses become popular?
Alienation clauses became popular in the 1970s when interest rates began to rise.
As a result, Congress passed the Garn-St. Germain Depository Institutions Act of 1982.
This allowed lenders to enforce alienation clauses with just a few exceptions.
See the next section for an explanation of all the top exceptions.
7. What are the exceptions to alienation clause enforcement?
Here are the most common exceptions for an alienation clause in real estate.
Keep in mind that lenders are never required to enforce an alienation clause; however, they are expressly prohibited from enforcing the clause under the following conditions.
Death: If the borrower dies and the deed is transferred to or inherited by a spouse (often, a co-borrower), child, or relative who is already an occupant or plans to become an occupant
Divorce: If a separation or divorce results in the borrower’s spouse becoming the property owner
Transfer to a living trust: If the borrower is the beneficiary and occupant, and transfers the property into a living trust
Assumable mortgage: If the loan predates the 1970s or is missing an alienation clause
Second mortgage: If a borrower takes out a second mortgage (like a home equity loan)
8. What’s the difference between an alienation clause and an acceleration clause in real estate?
An acceleration clause is a term in a loan agreement that requires the borrower to pay off the loan immediately under certain conditions.
The commonality that acceleration and alienation clauses share is that they allow lenders to demand full, immediate repayment at once, at their discretion.
That said, acceleration clauses have contract language that allows lenders to begin the foreclosure process.
This normally occurs when a borrower misses at least two mortgage payments.
You can check your mortgage contract terms for clarity.
Less often, loan acceleration can be triggered by the cancellation of homeowner’s insurance, failure to pay property taxes, a bankruptcy filing, or unauthorized property transfer.
In the case of a homeowner, an alienation clause is often celebrated while an accelerated foreclosure is a stressor.
9. What types of loans are barred from having an alienation clause?
Loans like Veterans Affairs (VA) loans, U.S. Department of Agriculture (USDA) loans, and Federal Housing Administration (FHA) loans are typically barred from having an alienation clause.
If buyers wish to take over these loans, they must be approved by the lender.
The lender will consider the same factors that they would for a new mortgage, including credit score, credit history as documented in a credit report, income, debt-to-income ratio, and your assets (cash in bank and retirement accounts).
If a buyer has a lot of equity in the property, meaning they have paid off a lot of their mortgage, the buyer must either have a lot of cash to pay for that part of the purchase price or be able to take out a second loan to cover that amount.
10. What’s the opposite of alienation in real estate?
The opposite of an alienation clause in real estate is an assumable mortgage.
Here’s how it works:
The buyer takes over the seller’s existing mortgage with all the terms intact
The buyer begins making monthly payments on the mortgage
The seller is released from any obligation or liability regarding the loan
An assumable mortgage can be beneficial for a buyer who isn’t in the best position to get prime loan terms.
Using this method, they can step right into a mortgage with an interest rate based on the previous owner’s credit history.
Assumable mortgages are exceedingly rare; although there are some FHA, VA, and USDA loans where this situation applies.
Assumable mortgages are still subject to lender qualifications before a mortgage transfer can be approved.
To qualify for assumption, the new buyer must meet certain credit-based criteria as well as specific underwriting guidelines.
You won’t know if your assumable mortgage is truly transferrable until the bank looks at the potential buyer’s credit.
11. How do you approach an alienation clause if you’re selling your property?
Having an alienation clause in your mortgage means that your lender expects you to pay your full remaining balance back at the time of sale.
This is the reason that this clause is referred to as a “due-on-sale” clause.
Here’s what you’ll owe at this time of sale:
The entire balance of the loan
All interest that has been accrued since the innovation of the clause
Once again, you do not have to pay back the “future” interest that would have accrued if the loan continued.
Please review the specific language found in your own mortgage contract regarding when and how you are required to handle repayment of your mortgage balance.
Homeowners who are living in financed homes aren’t permitted to simply carry those mortgages with them when they’ve moved.
Mortgages are tied to BOTH individuals and properties.
The mortgage application process necessitates that lenders look at borrowers’ financial situations and credit scores to assess risk.
The assessment of risk associated with property goes beyond credit scores to include factors like the appraisal and inspection.
Therefore, the mortgage process must be reset with each move to account for changing variables.
Final Thoughts
While an alienation clause is standard in real estate, it can be helpful to understand how it may impact you.
If you decide to sell your property before you’ve paid off your mortgage, you’ll likely follow the terms of the alienation clause.
If you’re helping an older family member to get their affairs in order, you may be interested to see how the alienation clause will impact their real estate.
Very old mortgages sometimes do not have alienation clauses.
Any loan dating back to the 1970s that is still active may not have an alienation clause as lenders cannot legally add it in or execute this clause simply because norms have changed since the mortgage was first issued.
So, be sure to read the fine print of your mortgage and understand your rights as a property owner.
At the end of the day, your mortgage is a contract.
There are specific situations when alienation clauses are and are not enforceable in real estate.
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Disclaimer: we are not lawyers, accountants or financial advisors and the information in this article is for informational purposes only. This article is based on our own research and experience and we do our best to keep it accurate and up-to-date, but it may contain errors. Please be sure to consult a legal or financial professional before making any investment decisions.
Prior to starting Gokce Capital, Erika received a Bachelor of Architecture from the University of Southern California and a graduate degree in Urban Policy from Columbia University. She worked as both an architectural designer and engineer in New York before joining the New York City Department of Housing Preservation and Development.
Erika currently lives in the New York Metropolitan area with her spouse, daughter and cat. She is originally from Chicago and still considers herself a midwesterner at heart.
Erika also loves to read, write and travel (fun fact, she has visited all 50 states and more than 30 countries!). Her new book, Land Investing Mistakes: 11 True Stories You Need To Know Before Buying Land, is now available on Amazon.