Certain words and phrases in real estate can sometimes be alarming. People often feel flustered when they come across terms in conditions in mortgage contracts. This article will discuss the alienation clause and what that looks like in real estate.
What is an Alienation Clause?
An alienation clause, also sometimes referred to as a “due-on-sale clause” is an agreement in real estate loan contracts that states the borrower is required to pay off the remaining balance of the mortgage immediately when there is a new buyer. This essentially means the transfer of a property title cannot be passed on to the new owner until the previous owner has paid the mortgage loan. This payment has to happen at the time of the sale or the transfer of the property title. This payment happens whether or not the sale or transfer is voluntary.
The alienation clause consists of legal language that releases the borrower of their obligations if the property is to be resold. The borrower must pay off the previous mortgage so that the mortgage is not transferred to the new buyer. The alienation clause essentially protects the lender and new buyer. The clause protects the lender as it requires the mortgage to be paid before the borrower is released from their obligations of the loan contract. Additionally, the clause protects the new buyer as they don’t become responsible for paying off the mortgage of the previous owner.
An Alienation clause is seen in almost all mortgage agreements in today’s real estate market. They are used so frequently as it protects both the lenders and the new buyers once a property is sold or the property title is transferred. Although very rare, you could come across a mortgage agreement without an alienation clause. Instead, it would most likely have an assemblage mortgage. An assemblage mortgage is when the new owners pick up exactly where the previous owner’s mortgage left off. Factors such as credit history are not factored in, and the new owners continue the previous owner’s mortgage payments.
How Does the Alienation Clause Work?
Once a borrower decides to sell their property, they request an official payoff statement from their mortgage company. In this payoff statement, typically the individual looking to sell their property collects the payment from the sale of the property from the new buyer and uses that money to pay off the rest of the mortgage. In some cases, the money from the sale will just go directly to the lenders or mortgage company, and they will apply that money to the previous owner’s mortgage to pay it off before the title of the property is transferred.
Once the previous mortgage is paid off, the new buyer is able to receive their own mortgage to pay. Here, the new owners need to obtain their own mortgage loan and their own financing. These new terms will only apply to the new buyers. These new terms will most likely include the alienation clause in them too, in case the new buyers chose to sell the property in the future.
The alienation clause is essentially a part of the acceleration clause. All acceleration clauses account for when a borrower fails to meet the conditions of their mortgage terms, this includes scheduled payments. If you are a borrower and you don’t pay your mortgage payments at the time they are due, your mortgage company could choose to institute an acceleration clause. Here, immediate payment is required and a failure to pay this could result in foreclosure. The alienation clause is technically part of the acceleration clause as it demands a mortgage payment at a certain time and failure to do so results in negative consequences.
Alienation clauses are typically easy for all parties involved. If the legal language in the mortgage contract is effective and clear to read, most borrowers have no trouble fulfilling their end of the agreement as they are prepared to pay off the remainder of the mortgage. The mortgage terms should be clear and state exactly how much will be owed by the current borrower at the time of the sale or transfer of property. Note that while current borrowers are required to pay off the remainder of the mortgage as well as any outstanding late fees, they are not required to pay interest that would have happened over the lifespan of their loan.
What’s the Difference Between an Alienation Clause and an Acceleration Clause?
Although the alienation clause is technically a part of the acceleration clause, they are separate clauses from each other. As discussed, an alienation clause requires payment of the rest of the mortgage at the time and the transfer of property to a new owner. An acceleration clause can be demanded anytime by a lender while an alienation clause cannot be. Lenders typically initiate the acceleration clause when they are starting the foreclosure process. When the borrower misses a series of payments, lenders begin the acceleration clause to demand the payments due. Other factors such as a cancelation of insurance, not paying property taxes, an unauthorized transfer of property, and bankruptcy can cause lenders to bring about the acceleration clause.
In What Situations Would the Alienation Clause Not Be Enforced?
In the 1970s, multiple court decisions ruled that the alienation clause could not be enforced. This led to lenders coming up with creative financing strategies to help protect them when they give out mortgages to people. The alienation clause not being able to be enforced ended in 1982. The 1982 Garn-St. Germain Depository Act ended the court’s rulings to put an end to the alienation clause, leaving it to be enforced in most mortgage terms and conditions.
Even though the alienation clause is seen in almost all mortgage contracts, there are special circumstances in which it is not included in the contract or not enforced. Certain mortgages don’t fall into the category of needing an alienation clause within its terms. Below will discuss the circumstances that a mortgage wouldn’t need an alienation clause:
Assemblage Mortgages: Ultimately, an assemblage mortgage means it is a mortgage in which the terms and conditions of one mortgage can be identically sent not picked up by a new buyer or owner. This was what most mortgages looked like in the 1970s. An assembled mortgage means the new owner can pick up exactly where the previous owner left off paying their mortgage, and the previous owner doesn’t need to pay off the rest of their mortgage.
A Second Mortgage: In the case, a homeowner takes out a second mortgage, an alienation clause would not need to be included in these second mortgages terms. Examples of second mortgages a homeowner could take out would be a home equity loan or a home equity line of credit. In second mortgages, the lender cannot demand a release of liability.
A Divorce: If a divorce is to happen and the title of a property is transferred, an alienation clause cannot be enforced.
Transfer of a Living Trust: If a property owner wants to transfer their property into a living trust they are allowed to without the alienation clause being enforced. This only applies if they are the occupant and the trust beneficiary.
A Joint Tenancy: A lender is not able to enforce the alienation clause if the mortgage is transferred to someone else a part of the morgue. This would happen if a living spouse solely took over a joint mortgage if their space has passed away.
A Death: If the property title is left in a will, the alienation clause is unable to be enforced by lenders. In this case, when the title of a property is in a life estate, left to a spouse, child, or another occupant of the property, the new property owner is able to take that morgan without the alienation clause being applied.
Additionally, there are certain loans that are unable to have an alienation clause. Some of these loans include Veteran Affair (VA) loans, U.S Department of Agriculture (USDA) loans, and Federal Housing Administration (FHA) loans. Homeowners interested to take out these specific loans must be approved by the lender. Lenders will consider factors such as credit score, credit history, and an overall credit report to be approved by these loans. Additionally, lenders will look into your debt to income ratio, as well as baking accounts and assets to be considered for such loans.
Why Do Lenders Use the Alienation Clause?
Ultimately, lenders use the alienation clause as a way to protect themselves. This protects them as the alienation clause ensures that lenders will be paid immediately if the previous borrower sells the property or ownership rights to the title of the property. Almost all mortgage contracts utilize the alienation clause so lenders are always protected. Borrowers may have unpaid debt at the time of their property sale and try to avoid paying the rest of their mortgage because they are too much in debt. That would mean the lenders would not get paid back and they would lose money. The alienation clause makes this factor nearly impossible for borrowers not to have to pay back their mortgage to their lenders.
Additionally, most of the time the lender does not know the credit score or credit history of the new buyer. The new buyer is usually an unknown thief party who will need to apply and receive their own mortgage based on their credit reports. The alienation clause protects the lender from possibly losing money to the new buyer from the previous owner’s mortgage, and protects the new buyers from having to pay off the previous owner’s mortgage. The credit history of all parties involved should be noted before the title of a property is sold or transferred.
Can the Alienation Clause be Applied in Leasing?
In short, yes the alienation clause is also seen in some leasing contracts. In a lease, the alienation clause prevents the individual leasing the property to sublet, transferring, or sharing the occupation of the lease with someone else. The terms of the alienation clause differ through each lease, but it could prohibit lease alienation or could ask for lessor permission before the lease is alienated. If you are interested in investment properties to lease, Start out your 7-day free trial with Mashvisor now to explore properties in your area to invest in.
What are Other Important Clauses in Real Estate?
Real estate is full of many laws that protect both the buyers, lenders, and any part involved. Although this article mainly focuses on the alienation clause, there are a few other notable clauses seen in mortgages.
The Defeasance Clause
The defeasance clause states that once the entire loan has been paid off by the borrower, the buyer gets the property. This clause mainly protects the buyer and ensures their right to the property they had taken the loan out for to become theirs once the loan has been paid off and there are no further payments. This means all outstanding loan payments that might have been missed must be paid off too before the property becomes theirs. Although some states don’t require this clause, it still might be beneficial to include it as it protects borrowers.
The Release Clause
This clause releases lenders’ rights to their portion of a property once a loan is paid back. This includes all interest rates and mortgage payments. Overall this clause protects buyers from their lenders keeping a portion of ownership of their property. Once the borrower has completely paid back the loan, then the lender has no right to own any of that property anymore.
In Conclusion
The alienation clause is a term in mortgage contracts that states the borrower must pay back the rest of their mortgage before they can sell their property or transfer the title of the property to someone else. This ultimately protects the lenders from losing money they had given out for a loan and ensures they are paid back. This clause also protects the new buyers from inheriting the previous owner’s mortgage. A new mortgage with new terms and continuous must be formed for the new borrowers based on their credit history and income. There are only some cases in which the alienation clause cannot be enforced, such as a death, divorce, or transfer of a living trust. Mashvisor specializes in all things real estate investments. To start looking for and analyzing the best investment properties in your city and neighborhood of choice, click here.