If you’re buying or selling a home that still has a mortgage on it, you’ll likely be dealing with what’s known the lending world as an ‘alienation clause’.
Also known as a ‘due on sale clause’, an alienation clause gives lenders the power to require the home loan to be immediately payable in full when the homeowner sells the property and the title is transferred to the buyer.
Essentially, a buyer cannot legally take possession of a home without an alienation clause being put into effect if it exists in the deed. Almost all mortgages will have an alienation clause, which basically does not permit the transfer of title on a deed without the current mortgage being paid off in full first.
When a buyer’s offer on a home is accepted by the seller, the buyer is then obligated to negotiate a new home loan contract with the lender under an alienation clause. During a change of ownership, the transfer of the mortgaged property requires that it be refinanced with a new mortgage agreement when an alienation clause is present in a loan contract.
In simple terms, an alienation clause means that sellers have to pay their loans off in full, and buyers have to take out a completely new mortgage.
Alienation clauses also affect homeowner insurance policies. Once homeowners sell their properties, any insurance policy that exists will cease, and the new owner would then have to take out a new policy.
How Does an Alienation Clause Affect Assumable Mortgages?
When a mortgage is assumed – known as an ‘assumable mortgage’ – the buyer takes on the existing mortgage along with the old interest rate.
The new owner essentially assumes the previous owner’s loan and terms without having to secure a new mortgage. Instead of having to apply for a new mortgage from a lender, a buyer can just take over the existing mortgage, along with the outstanding principal amount, interest rate, monthly mortgage payments, and other terms associated with the mortgage.
But with an alienation clause in a loan contract, a mortgage would not be able to be assumed. This clause gives the lender the right to require that the mortgage becomes due and payable once title is transferred from the seller to the buyer.
Many times the rates on existing mortgages are not in line with current market conditions, so banks started using alienation clauses to prevent old rates from being assumed. Instead, buyers would have to take out a new mortgage with a new rate that matches present housing market conditions.
If a seller wants the buyer to take over the existing loan on a home, an alienation clause would prevent that from happening. Alienation clauses essentially impede on assumable mortgages.
Are Alienation Clauses Always in Effect?
Even if an alienation clause exists in a mortgage, the lender doesn’t necessarily have to exercise the right to have the existing mortgage paid off in lieu of a new mortgage taken out. The lender essentially has a choice whether or not to act on the clause.
In other cases, there may be situations where the lender could actually be prevented from exercising an alienation clause. For example, a surviving joint tenant could take over title to a property when one of the homeowners on title passes away. In this case, the other owner would take over without having to pay off the remainder of the mortgage when title is transferred.
The same goes for title transfer when a home is passed down to heirs through inheritance. In this particular case, the relative who takes title must actually take possession and occupy the property.
Lenders are also not legally allowed to enforce an alienation clause if the homeowner takes out a second mortgage. In this situation, the lender holding the first mortgage can’t exercise the alienation clause and force the homeowner to pay the loan in full.
The Bottom Line
If you’re buying a home, you’d be well advised to find out if there’s an alienation clause in the seller’s current loan contract that would require you to take out a completely new mortgage or assume the existing one.
Sellers should also verify whether or not an alienation clause exists, which would require them to pay the mortgage off in full using the proceeds of the sale. Either way, your mortgage broker will be able to take you through the process and identify any clauses that would impact the purchase or sale of a property.