Alienation Clause Example

Seller Sanchez would like Buyer Thompson to assume his existing loan.  Which of these clauses in Seller Sanchez’s loan may create an impediment for Buyer Thompson to assume Sanchez’s loan?

  1.  subordination clause
  2.  alienation clause
  3.  release clause
  4.  escalation clause

The answer is B – An alienation clause – also known as a due on sale clause will create an impediment for Buyer Thompson to assume Seller Sanchez’s loan.

By definition, an alienation clause  gives the lender the right to call the loan due and payable if the borrower conveys legal title to a new owner.  So, since title will be conferred to Buyer Thompson, the lender does have the right to say that Seller Sanchez must pay the loan, which means that Buyer Thompson may assume this.

Why did banks being to use the due on sale clause?

Banks started to use “due on sale” clauses in their mortgages in the 1970s when interest rates were very high.

Home buyers were just taking on existing loans instead of taking out new loans (which would have higher rates) from banks because the interest rates on pre-existing loans were much lower.  This of course saved home buyers money.

In order to counteract this, banks began to use due on sale clauses, which could force new buyers to take out another loan.