What exactly is the alienation clause found within mortgage terms?
Simply put, the alienation clause is a provision found within a mortgage (or trust deed) that gives a lender the authorization to call the outstanding loan due and payable, if:
This clause is sometimes referred to as a ‘Due-on-Sale Clause.’ Alienation clauses are included in almost all commercial real estate loans and mortgage documents. From a legal perspective, the alienation clause prevents a buyer from receiving a ‘clean title’ to the property because the actual sale of the home triggers the mortgage’s alienation clause – the mortgage is now due and payable.
What is the history of the alienation clause?
Nowadays, it is nearly impossible to find a commercial property loan, or residential loan, that does not contain an alienation provision. And while the alienation clause’s verbiage might not specifically state it as such, the reality is, the inclusion of an alienation clause prohibits any real property titles to be transferred without the requirement to pay off the existing mortgage.
Alienation clauses hit mainstream media somewhere in the first few years of the groovy 1970’s. The 1974 Tucker v. Lassen S & L landmark decision tested the boundaries of the laws impacting installment land contracts.
It is important to remember that the 1974 real estate market barely resembles the marketplace of today.
Interest rates were in the teens (and rising steadily). Smart buyers were choosing to hold onto the lower rates of existing loans, rather than to apply for a new mortgage with a guaranteed higher interest rate. Real Estate financing was creative. The alienation clause loophole became a financing strategy.
Jump four years forward to the 1978 court case of Wellenkamp v. Bank of America. This was California’s second landmark decision confirming that a lender could not enforce the ‘due on sale’ clause if the loan’s collateral was not damaged or, in danger of being damaged.
This decision opened the door that allowed buyers to sidestep the roughly 18% rate environment. Most agree, however, that this is likely also the time of the birth of ‘Get Rich Overnight’ real estate seminars. This was clearly a money-making opportunity which unfortunately led to overwhelming fraud and abuse.
Several years later, Congress passed the 1982 Garn-St. German Act, which slowed the pace of creative financing options. This act allowed for the transfer of titles into trusts without triggering the alienation clause. Title VIII of the Act, known as Alternative Mortgage Transactions, now permitted lenders to offer a newfangled mortgage, the Adjustable Rate Mortgage (ARM). Shortly after though, interest rates began to fall a bit, so the changing interest rate environment made in no longer necessary to hold onto existing mortgages because new mortgages were offered at reduced rates. This opened the playing field for government loans, conventional loans, and commercial real estate loans.
Eventually, the abuse of adjustable rate mortgages, as well as the negligent use of the 80/20 combination financing package, led to the 2007 crash of the subprime market. Over ten years later, the real estate market has solved most of the pressing issues that led its bust, that is, with the federal government’s help. Ten years later, commercial loans and residential loans have almost reached a nearly corrected marketplace. But remember, the real market as a whole, is, and will always be directly connected to the mighty financial markets.