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Understanding the alienation clause in your mortgage contract
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An alienation clause — also called a due-on-sale clause — is a type of standard clause that’s generally mentioned in almost every mortgage agreement. In fact, it’s hard to find a mortgage contract that doesn’t mention some type of alienation clause.
The reason home loan lenders include this clause in all the legal agreements (for both commercial as well as residential properties) is to prevent new buyers from taking over an existing mortgage.
So basically, an alienation clause gives the lender a kind of assurance that the debt will be fully repaid. Especially, in case there’s a real estate sale or a property transfer during the loan term.
In the case of a home sale, the clause releases the borrower from their obligations to the lender only when the proceeds from the home sale go into paying off the mortgage balance.
The same logic is applied in the case of a property insurance policy. If property ownership is transferred or if the property is sold, this clause requires that the new homeowner obtain new insurance in their name for the property.
What is an alienation clause in the world of real estate?
Alienation clause is a provision that’s found in almost all financial or property insurance contracts. The clause typically allows the transfer or sale of an asset only when the main party fulfills its financial obligation. This clause gives the lender a kind of security that their money will be repaid completely.
The borrower must pay back the mortgage in full before they can transfer the property to another person.
The clause initially became popular in the 1970s in response to the changing market conditions then. The U.S. Congress, after having passed the Garn–St. Germain Depository Institutions Act of 1982, allowed lenders to enforce the alienation clauses, of course with some exceptions.
Exceptions to alienation clause
Loan lenders cannot enforce any of the alienation clauses under the following conditions:
- Death: In case a borrower dies, the deed transfers to the spouse, child, or a relative living in the house.
- Divorce: In case of a separation or divorce when the borrower’s spouse becomes the property owner.
- Transfer to a living trust: In case the borrower is the beneficiary and transfers the property into a living trust.
- Assumable mortgage: If the loan agreement was made before the 1970s or doesn’t mention an alienation clause. In such a scenario, the new owner is not required to pay off the remaining mortgage.
- Second mortgage: If a borrower takes out a second mortgage or a home equity loan. In such a case, the primary mortgage lender cannot demand a release of liability.
How do alienation clauses work?
An alienation clause has been created to protect the moneylender. Therefore, it’s extremely crucial for a home buyer to understand how the policy works before buying a home.
If there’s an alienation clause in your mortgage contract, you must agree to pay back the full loan amount, and any late interest fees you’ve accrued, as soon as you complete a sale of the property or transfer of the title.
Keep in mind that in case of a real estate sale, the proceeds from the sale will be used to pay off the loan first and then to the seller.
That is to say, the seller cannot transfer the existing loan to the new homebuyer. Once the loan is repaid by the previous owner, the new buyer must apply for financing — with new interest rates and terms.
Difference between the alienation clause and acceleration clause?
While both acceleration and alienation clauses allow a loan lender to demand complete, immediate repayment of a debt, there is some difference in the way both are executed.
In an acceleration clause, the contract language states that the lender can begin the foreclosure process if the borrower has missed two mortgage payments.
Loan acceleration is generally triggered by a cancellation of the homeowner’s insurance, their failure to pay property taxes, or if they’ve filed for bankruptcy.
An alienation clause comes into effect only in the event of a house sale or property transfer. To put it as simply as we can, while an alienation clause in action is a celebration of sorts for the borrower, an accelerated foreclosure is a huge stressor.
That’s why it’s always best to double-check your mortgage contract terms before signing on the dotted line.
The alienation clause allows a lender to end a borrower’s contractual obligation on full repayment of a mortgage. And, it compels the borrower to pay back the loan amount before making any other real estate transaction.
The clause comes into action when the financial asset in question is either sold or transferred to another entity. An alienation clause prevents new property buyers from taking over an existing mortgage.
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