Every week I receive questions about how to transfer real estate into an LLC. There seems to be a growing notion that transferring one?s home into an LLC will protect it from creditors and taxes and all things unsavory. The problem arises when the property, whether it be a rental, investment or primary home is mortgaged, because then the ?due on sale? clause comes into play.
The ?due on sale? clause, also known as an ?acceleration clause,? typically reads as follows: ?If all or any part of the property herein is transferred without the lender’s prior written consent, the lender may require all sums secured hereby immediately due and payable.? In other words, the lender has the right to choose to accelerate the mortgage so that the entire amount is due at the moment it is transferred into the LLC. If the homeowner cannot pay, the lender can commence foreclosure proceedings.
The ?due on sale? clause originated in the 1970s when mortgage interest rates rose sharply. Rather than obtaining new financing at the exorbitant rates in which banks demanded, homebuyers were simply assuming existing mortgages after the seller transferred the property to them. Lenders ultimately responded to this phenomenon by incorporating the ?due on sale? clause into the mortgage contract. The clause essentially forced buyers to incur debt at the higher market rate. Community Title Co v. Roosevelt Savings & Loan 670 S.W.2d 895 (Mo.App. 1984). It also made mortgages due in full when heirs inherited property and when ex-spouses became sole owners of homes in divorce settlements.
Homeowners tried to fight the lenders? actions by arguing that the ?due on sale? clause was an unfair trade practice. The arguments fell on deaf ears, as the United States Supreme Court eventually weighed in, and sided with the lenders. Fidelity Federal Savings and Loan Association v. de la Cuesta, 102 S.Ct. 3014 (1982).
Congress subsequently enacted the Garn-St. Germain Federal Depositary Institutions Act, 12 U.S.C. 1701-j et seq. The Act provides that the ?due on sale? clause is unenforceable if the title is transferred to an heir, if the property is transferred in the event of a divorce, or if the property is transferred to a living revocable trust. Importantly, the Act does not prohibit the ?due on sale? clause if the property is transferred to an LLC. [br]
What does this mean for homeowners who want to transfer the property to an LLC or other corporate entity?
- First, check to see if the mortgage documents contain a ?due on sale? clause. Some older mortgages and private mortgages, amazingly, do not.
- Second, if the mortgage does contain a ?due on sale? clause, do not try to avoid it. Under no circumstances should anyone try to transfer the property secretly or under the table by not recording the new deed. This course of action will end badly once the lender discovers the ruse.
- Third, as distasteful as it is, obtain your lender?s consent to the transfer prior to the transfer. Many lenders will permit the transfer of the property into an LLC provided that the original borrowers remain liable for the mortgage in the event that the LLC defaults on the payments. In addition, lenders may be more amenable to the transfer if the LLC is a going concern and has its own (good) credit history.
Transferring real estate into an LLC can provide valuable protection for homeowners and landlords. But it can also be fraught with peril thanks to the ?due on sale? clause. Before pursuing this option, be sure you know what the mortgage documents state regarding transfers, and ensure that transferring the property will be a true benefit to your financial landscape.
SMART TIP: When obtaining the consent of your lender to transfer real estate into an LLC, make sure that the lender?s consent is in writing, and signed by the lender. Telephone conversations and email communications are insufficient to alter the terms of a mortgage loan.