Navigating Assumed Mortgages: Understanding the Due-On-Sale Clause and its Implications

February 13, 2024 Stephen Aron Benson James S. Samuelson Real Estate Law

Not long ago, interest rates on new residential mortgages in Arizona hovered around three percent. With interest rates having increased over the past eighteen months, new mortgages are more likely to be in the six or seven percent range. This generally has the effect of lowering the temperature on the buyer’s side of the equation (i.e., monthly payments are considerably more than they would have been at a lower interest rate), which raises a question about whether a buyer can make use of the seller’s existing low-interest rate loan to make the transaction more advantageous for all concerned. In attorney talk, this usually means that the seller leaves the existing mortgage in place, with the buyer taking the property “subject to” the existing loan or expressly assuming the obligations under the existing mortgage loan (and sometimes utilizing what used to be called a “wrap around” carryback loan, where the new buyer pays the old buyer who continues to make the loan payments).

This scenario has, as in the case of most economic trends, happened before. Lenders naturally prefer to have their old, low-interest- rate loans paid off (so that the lender can re-lend the money at a higher interest rate), thus lenders are not fans of buyers leaving existing loans in place when a home is sold. The last time interest rates rose significantly, commercial lenders closely followed recorded housing transfers to make sure owners were not “secretly” selling a property with the existing loan in place. A brief, casual history may be in order here.

In the late 1960s, lenders started including “due-on-sale” clauses in mortgages, whereby the entire debt becomes immediately due and payable at the lender’s option upon a sale or transfer of the property. During that time period, Arizona was one of a minority of states that made it difficult for lenders to enforce due-on-sale clauses, with Arizona requiring that a lender show that its security was impaired in order to enforce a due-on-sale clause. Specifically, Arizona enacted A.R.S. § 33-806.01, which, among other things, limited how much a lender could increase the interest rate on an “assumed” mortgage. Ultimately, the United States Supreme Court ruled that due-on-sale clauses are enforceable despite conflicting state regulations. Thereafter, in 1982, Congress passed the Garn-St. Germain Act, part of which provides that due-on-sale clauses are fully enforceable according to their terms. The Garn Act does contain some restrictions on enforcement of due-on-sale clauses, such as when the transfer is the result of the death of the borrower or from a separation or divorce, but, in summary, as of October 14, 1987, due-on-sale clauses are enforceable in Arizona.

Even if lenders choose not to enforce their due-on-sale clauses, trying to buy a property subject to an existing mortgage can have its challenges. First, title companies (which close most house transactions in Arizona) like to get a balance statement from the lender so that they can accurately figure the dollars involved at closing and some lenders are not motivated to make this a smooth process. Also, it is unclear whether lenders will require the new buyer to go through a qualification process. Second, sellers would understandably want to be released from the loan; which may not be a huge factor because Arizona is a “non-deficiency” state, and sellers might want comfort on that point (yet lenders are not required to give a specific release). Thirdly, the numbers might not work; the amount of the existing mortgage may not be at the level that the potential buyer needs to make the transaction work and the lender is unlikely to advance more money (i.e., make the mortgage larger) at the same rate as the old transaction. While it is theoretically possible that the buyer could get a second, subordinate loan (to bring the debt to a level that is necessary to close the deal), many loan documents contain a prohibition on having “junior” liens. Finally, it can be difficult to actually track down and communicate with the lender, since most residential loans are sold, sometimes into a “pool” where you have to deal with servicing agents, making actual answers and information hard to come by.

It is unknown how many contracts involving real property loans are being “assumed” by buyers in today’s market. It is clear that these assumption transactions are a bit more complicated than cash or new mortgage transactions – and likely in violation of the mortgage documents, giving lenders the right to “call” the mortgage loan. That said, because there could be relatively substantial amounts of money at stake (residential mortgages in the half-million-dollar range are no longer rare in Arizona) a difference of three points or more to service a debt can be substantial. Thus, it is likely that Arizona attorneys will start to see more residential transactions while mortgage rates remain relatively high. 

If you have questions about due-on-sale clauses or other real estate-related issues, please contact Stephen Benson or Jim Samuelson.