Newsgroup>> Due on sale clause
Due on sale clause
Posted by: Reds Posted on : 3/11/2010 9:29:33 PM
I own a property I pruchased and rehabbed with a line of credit I have on my primary residence which is low now but has a very high cap rate of %18. I want to sell on a land contract and try and capture the $8000 first time home buyer's money before the April 30th cut off. What would be the right course of action to take so as not to cause a mortgage company to call me on the due on sale clause. In other words, because of the time restraints should I do a land contract right away and then try to refi later or should I do them simutaneously, or is my situation not right for a refi and a land contract?
Reply
Some DOS Talk....
Posted by: Hyre Posted on : 3/12/2010 10:35:59 AM
If the mortgage is on your primary residence and the funds from the mortgage were used to buy a separate property, then DOS is not an issue, as the mortgaged property is not the one being sold on LC. As such, no violation of the DOS would exist. It may be that I misunderstood the context of what is/shall be mortgaged, and that the DOS could then be relevant. I have not posted on this topic in a while, so here's my general take on DOS: For those of you not familiar with DOS, it is basically a clause found in the vast majority of loan contracts that permits a lender to call a loan due (and foreclose if need be) if title to the underlying property is transferred. "Title transfer" normally includes sale on land contract and lease-options with more than a three year term. The DOS does not exist because banks are “mean”. Rather, it exists to protect them from being on the hook for lending to someone other than the original borrower, though its application is often broader than that. The Garn St. Germain Act of 1982 restricts a lender's ability to apply the DOS in certain situations. Guru lore has it that trusts “get around” DOS because of the Garn St. Germain Act. In my opinion, that is incorrect. Rather, only trusts established for legitimate estate planning purposes (e.g. living trust) are exempt from DOS. Other types of trusts (e.g. Land Trusts) are not exempt. In short, I do not think that most trusts “get around” DOS. In fact, it can be argued (and has been argued by at least one state Attorney General in a sub2 context) that using a trust (other than a legitimate estate planning trust) to hide the bank's right to apply DOS is a deceptive business practice, punishable with heavy fines, injunctions, and in some states, criminal sanctions. I would not count on a trust to protect you from DOS in a non-estate-planning context. I see two primary options to dealing with DOS when selling on LC: 1)Do Nothing. Do not hide the transaction. Do not step forward and announce it. In the current economic climate, banks are not generally looking for reasons to foreclose, including DOS issues. The likelihood is strong that such a breach will go unnoticed for years. The downside: When interest rates get to double-digits (and they will if Obama/Carter, Jr. keeps at it – you knew I had to slip something like that in), the banks start looking for reasons to call low-interest loans due and use the money to lend at higher rates. This is exactly what happened in the late 70's and early 80's, and what ultimately led to the Garn St. Germain Act that placed some limits on DOS. Once rates go up, banks will be looking for reasons to call loans, starting with older, dormant DOS issues. If you are not in a position to refinance at that time, it could spell trouble for you, your buyer.....and unhappy buyers of course spell more trouble for you. 2)Beg Forgiveness Now: Do not ask for permission. Given how bureaucracies function, you probably won't get it. Rather, send a letter via certified mail, return receipt, “begging forgiveness”. Explain that you sold the property on land contract in order to make the payments and end with “please contact us if this is a problem”. In other words, if you hear nothing – great! Make sure that the letter goes to the correct “notice” address (in your loan agreement) and not to where the bills go. Upside: Right now, banks are not looking for more non-performing loans. In our experience, such letters are ignored most of the time. Even when the banks respond with something unfriendly, they usually back down when pressed – why mess up a performing loan? Here's a dual benefit from this approach: First, you have been completely above-board. Second, if the banks do nothing and then look to the DOS as an excuse to call a loan due in a few years, you have a strong argument that they waived their rights. In other words, they knew about the DOS issue (hence the return receipt, certified mail), chose not to do anything about it, and kept taking your money. You'd have to see how the waiver defense applies in your state, but what I just described are the classic elements of such a defense. Downside: In a minority of cases, the bank will stupidly press forward, call the loan due, and move to foreclose. That is presently rare, but in a country of 300 million people, you do have some who are that dumb. In short, each approach has its risks. Note: When you contribute a property held in your name to an LLC or other entity, you have a similar DOS issue, with one advantage: If the bank gets difficult, you can usually “cure” the breach by deeding back into your name. With a Land Contract, it is hard or impossible to “cure” and a foreclosure means you need to set things straight with your buyer, usually by refunding everything except “fair rent” for the time they were in the property. Just some thoughts from what I've seen happening with clients. John Hyre Attorney, Accountant, REI www.realestatetaxlaw.com
Re:Some DOS Talk....
Posted by: mbgaskins Posted on : 3/12/2010 3:52:33 PM
John, Excellent advice. We actually sold one of our houses with a recorded mortgage and deed transfer. We called the president of the bank (small local bank) and discussed this with him. He was not the least bit concerned about his DOS clause but was more concerned about why we would want to do this. After we explained that our risk was little more than what it was renting the place and that we understood that we were still responsible to him to make the payments to his bank, he had no problem at all. Brad
Posted by: Reds Posted on : 3/12/2010 7:31:26 PM
John- Thanks a million for your awesome advice, I'm sure many of the advanced investers learned a wealth of knowledge. The investment property purchased and rehabbed with the line of credit from my primary residence is free and clear. However the property is now elgible for a 75% cash out mortgage at 6%, but it won't be enough to pay off the full amount against the primary home, which is my disire since that line of credit is cheap now, but can cause me great grief in the future in this Obama/Carter era. So I thought a land contract with the first time home buyer's credit and any down payment I get would accomplish my objective of paying off the line of credit. Now if I'm understanding what you opined about the DOS clause of a land contract over three years, I'm thinking I can do a land contract for three years, (since there is still enough time left) and still be able to come back afterwards and do the cash out without the new mortgage being denied because of the land contract. I don't know if my assumption is correct and would greatly appreciate your advice on this . If it turns out to be true than I will purchase your course right away to get the job done right. Thanks
Posted by: Hyre Posted on : 3/13/2010 2:00:12 PM
To clarify: All LC trigger DOS from what I have seen. In addition, L/O of 3+ years do so as well. We have seen A LOT of sales on LC to get FTHB tax credit and have seen < 1% run into DOS issues when following 1 of 2 approaches that I described. Small, local banks also seem most likely to give explicit permission to proceed, as long as purpose is explained to them, as MB Gaskins described. John Hyre www.realestatetaxlaw.com
© shortsalewealth.com