When purchasing a home, it is common to get a residential mortgage. This type of mortgage is usually backed by the Federal Housing Administration (FHA) and enjoys lower interest rates and down payments. These are very attractive to buyers, but they have a big catch: they are for primary homeowners and not investors. Practically, this means that the buyer must live in the home that was purchased with the loan. Here are some reasons that the bank might want to be able to exit the loan.
Government Reasons
The FHA counts on banks to determine creditworthiness and whether the lendee fits certain criteria, such as this primary residence requirement. Banks aren’t in the enforcement business, but they usually follow the letter of the law, and are monitoring for people abusing this system. Banks also get audited occasionally. If a lendee sells, the bank wants to have a way to get out of the mortgage.
Unknown New Buyers
People getting loans often have amortizations of 20 to 35 years. They probably won’t live in the house for that long. Usually when they sell, the new buyer pays them through the title company and a big chunk gets taken out to pay off the seller’s mortgage. Sometimes, the new buyer can just take over the loan responsibility and make the payments to the bank. This is called assuming the loan. Unfortunately for the bank, this presents a huge risk. The new buyer is not a known quantity and might not be counted on to pay the mortgage back. Banks don’t like this.
Investors
An individual might have lived in his home but wants to rent it out. This is often the issue with investors who are abusing the system, but they may have had an epiphany and decided to become landlords. They might have had a major family change like the birth of a child and needed to ‘trade up’. These people might choose to rent the house out rather than to sell. They might want to put ownership into an LLC instead of their own person for protection. From the eyes of the bank, this increases risk, because the home is no longer occupied by the owner, who might be counted on to take care of the place well. A renter might not be so careful with the property.
The Due On Sale Clause
For all these reasons, banks often insert a Due On Sale clause into their mortgages. This clause gives banks the option to call the entire loan due once the property is sold to another buyer. This can be scary for owners because they might not have the money to pay back the entire loan. An example would be when a buyer wants to purchase from the seller in a subject-to sale. The deed is transferred to the buyer subject to the conditions of the agreement, such as paying back a certain number of payments. Buyers like this because they often don’t need so much money as a down payment. This transfer triggers the due-on-sale clause and the bank has the option to call the loan due. If that happened, the new buyer probably wouldn’t be able to pay the loan and the deal would die.
On the other hand, these clauses are only options for the bank. Banks often don’t exercise them. In fact, I’ve transferred a primary residence to my own LLC to rent out the property. I spoke with the bank about this and they agreed. I satisfied the FHA requirements by having lived in the property. It worked out well. The bottom line is to never try to be sneaky but to involve the bank. Usually they can help you.
