Contracts are a critical component of the business sector since they serve as lawfully enforceable agreements between parties. Each contract contains a few arrangements that outline the agreement’s terms and each party’s commitments. One example of such a provision is the alienation clause found in most property loan agreements. In this post, we are going to go through the specifics of the alienation clause and how it works.
What is an alienation clause in real estate?
An alienation clause in real estate, also known as a due-on-sale clause or a non-assumption clause, is a condition in a contract that gives the lender the right to demand full payment of a loan when the borrower transfers ownership of the property that acts as collateral. In other words, the lender has the right to request prompt repayment of the remaining loan balance if the borrower sells, transfers, or otherwise conveys the property to a third party.
How does it work?
Loan agreements with the alienation clause often cover mortgages, deeds of trust, and other secured loans. In this situation, the lender has the discretion to request immediate repayment of the entire loan balance.
Consider John, who has a mortgage with XYZ Bank on his property. In the event that John sells or transfers ownership of the property to another party, the mortgage agreement contains an alienation clause that gives the lender the right to demand full repayment of the loan. If John decides to sell his house, he will first need to pay off the remaining mortgage sum. If he doesn’t, the lender has the right to demand full payment and potentially start the foreclosure process.
Why is an alienation clause used by lenders?
Contracts with lenders typically have an alienation clause to safeguard their rights and lower the likelihood of default. The alienation provision safeguards the lender’s interests by granting the lender the authority to request full repayment of the loan when the property is sold or transferred.
How is it different from an acceleration clause?
An acceleration clause is another provision often included in loan agreements, but it works differently than an alienation clause. The acceleration clause gives the lender the right to demand immediate payment of the entire loan balance if the borrower defaults on the loan or violates the terms of the contract. This means that the lender can accelerate the repayment schedule and require that the loan be paid in full before the original payment date.
When is an alienation clause not applicable?
Although it is quite common in lending agreements secured by property, the alienation clause may not always be suitable. The alienation clause is usually not enforceable, for instance, if the property has been transferred as a result of an inheritance, a divorce, or a death. These circumstances can involve a transfer of ownership that is not voluntary, and the borrower may not have any control over them. This suggests that the lender generally will not have the right to demand payment of the entire loan balance.
Furthermore, the alienation clause usually does not apply if ownership is transferred through a legitimate entity like a trust that is controlled by the buyer. Because of this, the transfer of ownership in certain situations is not a sale or transfer to a third party, and the lender often won’t have the right to enforce the loan.