Garn-St. Germain, Trusts, and the Due-On-Sale Clause

Trusts are a common estate planning tool used to meet a variety of estate planning goals. To maximize trust benefits, estate planning professionals frequently advise their clients to transfer real property into trusts. Placing real property in a trust can achieve estate planning goals like avoiding probate, reaping tax benefits, ensuring real property passes according to the client’s desires, and providing creditor protection.

Transferring real property to a trust, however, poses some risks if the property has a mortgage. Most mortgages contain a due-on-sale clause, which upon the sale or transfer of the real property allows the lender to accelerate the mortgage and make the entire mortgage balance due. The risk in transferring real property to a trust for estate planning purposes is that the transfer could trigger the due-on-sale clause and cause the lender to accelerate the mortgage. Once the mortgage accelerates, the borrower then must repay the entire balance of the loan.

Congress, anticipating this problem, passed the Garn-St. Germain Depository Institutions Act of 1982 (“Garn-St. Germain”). This act has a primary purpose of upholding due-on-sale clauses, but carved out several important exceptions where due-on-sales clauses do not apply.

For estate planning purposes, the most significant exception applies to residential real property transferred to a revocable living trust where the borrower is a beneficiary of the trust and retains the right to occupy the property. This exception applies to residential real property containing one to four units or stock allocated to dwelling units in a cooperative housing corporation. Most homeowners seeking to transfer their personal residence to their revocable living trust will fit under this exception.

It is important to understand when the exception to Garn-St. Germain applies and when it does not apply. It likely will apply when a client transfers their personal residence to their revocable living trust. This exception, however, does not generally apply to irrevocable trusts, commercial property, and limited liability companies owning residential real estate. When the exception does not apply, the client should obtain lender pre-approval prior to transferring any real estate for estate planning purposes to ensure they do not violate the terms of their mortgage.

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