The purpose of the Garn-St. Germaine Depository Institutions Act of 1982 is the “permanent preemption of state prohibitions on the exercise of due-on-sale clauses by all lenders, whether federally or state-chartered, [and] to reaffirm the authority of Federal savings associations to enforce due-on-sale clauses, and to confer on other lenders generally comparable authority with respect to the exercise of such clauses.”

That said, the Act contains some limitations on that authority:

§ 591.5  Limitation on exercise of due-on-sale clauses.

(a)  General.  Except as provided in § 591.4(c) and (d)(4) of this part, due-on-sale practices of Federal savings associations and other lenders shall be governed exclusively by the Office’s regulations, in preemption of and without regard to any limitations imposed by state law on either their inclusion or exercise including, without limitation, state law prohibitions against restraints on alienation, prohibitions against penalties and forfeitures, equitable restrictions and state law dealing with equitable transfers.

(b)  Specific limitations.  With respect to any loan on the security of a home occupied or to be occupied by the borrower,

(1)  A lender shall not (except with regard to a reverse mortgage) exercise its option pursuant to a due-on-sale clause upon:

(i)  The creation of a lien or other encumbrance subordinate to the lender’s security instrument which does not relate to a transfer of rights of occupancy in the property: Provided, That such lien or encumbrance is not created pursuant to a contract for deed;

(ii)  The creation of a purchase-money security interest for household appliances;

(iii)  A transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety;

(iv)  The granting of a leasehold interest which has a term of three years or less and which does not contain an option to purchase (that is, either a lease of more than three years or a lease with an option to purchase will allow the exercise of a due-on-sale clause);

(v)  A transfer, in which the transferee is a person who occupies or will occupy the property, which is:

(A)  A transfer to a relative resulting from the death of the borrower;

(B)  A transfer where the spouse or child(ren) becomes an owner of the property; or

(C)  A transfer resulting from a decree of dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement by which the spouse becomes an owner of the property; or

(vi)  A transfer into an inter vivos trust in which the borrower is and remains the beneficiary and occupant of the property, unless, as a condition precedent to such transfer, the borrower refuses to provide the lender with reasonable means acceptable to the lender by which the lender will be assured of timely notice of any subsequent transfer of the beneficial interest or change in occupancy. (Emphasis supplied)

A cursory reading of this statute will demonstrate that though transfers to inter vivos trusts are exempted from the due-on-sale provisions of Garn-St. Germain, for example, transfers to LLCs are not. Thus, if your clients deeds her personally own, mortgage-encumbered rental property into her single-member LLC (SMLLC) of which she is the sole member, she risks her mortgage lender calling the loan—that is, the loan being immediately due and payable.

What to do? Interestingly, different attorneys give different advice. Some will say that the safest path is to call the mortgage lender and let them know what is going on—essentially ask permission. They’ll then say, “but why bother? The lender will never find out anyway.” Actually, it may be true that lenders don’t spend much time policing property records in an effort to catch borrowers transferring real estate into their LLCs—I’ve heard this a lot, but who knows if it’s true? However, the safest path is also the best path, and in most cases, it will be a relatively easy one. But when you make that call, make sure you keep talking until you talk to a person who knows what they’re doing.

The due-on-sale concern will arise in two situations: 1. In a new purchase where the lender says the purchaser/borrower must buy the property in her own name, and the purchaser/borrower intends to transfer it into an LLC post purchase; and 2. Where the purchaser/borrower has owned the property in his own name for a while and decides he wants to transfer it into an LLC—the old purchase.

New Purchases. In this situation, it’s simply a matter of being up front with the lender from the beginning. The borrower should explain their intentions and get the lender’s approval in writing prior to signing the loan, when she has leverage. Lenders see these situations all the time, and most will agree and even facilitate the transaction. Some may require guarantees by the LLC, signed by its members or managers accompanied by a resolution or other statement of authority evidencing their authority to sign.

Old Purchases. This situation is more problematic. The lender has the leverage, and if rates are up, it’s in the lender’s interest to call the loan. In such an environment, it may be worth the risk to transfer to the LLC and ask forgiveness later—if ever. Chances are, the lender will never know. But if the lender discovers that your client transferred the property and if rates are up and the client’s financial situation has deteriorated, trouble may ensue. If rates haven’t changed much and if the client is able to refinance if necessary, the existing lender may be more willing to allow the transfer without calling the loan.

It’s virtually always best to talk to your lender before you make a transfer; otherwise, you risk the lender calling your loan. And besides, do you want a good or a bad relationship with your lender. Yeah, I thought so.