Legal Definitions - due-on-encumbrance clause

A due-on-encumbrance clause is a specific provision found in a mortgage agreement. It grants the original lender the option to demand immediate repayment of the entire outstanding loan balance if the borrower places another significant financial claim or lien on the mortgaged property without the lender's prior written consent.

Essentially, this clause protects the primary lender's interest by preventing the property from becoming over-leveraged or having its value diluted by additional debts secured against it. If the borrower takes out a second mortgage, a home equity line of credit, or another type of loan that uses the property as collateral, the original lender could invoke this clause and require the borrower to pay off the entire first mortgage immediately.

Here are some examples to illustrate how a due-on-encumbrance clause works:

• Example 1: Homeowner seeking a home equity loan for renovations

  Imagine Sarah owns a home with a primary mortgage from Bank A. She decides to undertake a major kitchen renovation and applies for a home equity loan (which is a type of second mortgage) from Bank B to finance the project. If Sarah's original mortgage with Bank A contains a due-on-encumbrance clause, Bank A could, upon learning of the new home equity loan from Bank B, demand that Sarah immediately pay off her entire original mortgage. This is because she placed another financial claim (the home equity loan) on the property without Bank A's permission, potentially increasing the risk for Bank A.

• Example 2: Small business owner using commercial property as collateral

  Consider Mark, who owns a commercial building for his business, financed by a mortgage from Lender X. His business needs to expand, so he seeks a business expansion loan from Lender Y, offering his commercial building as collateral. This action creates a second lien on the property. If Mark's original mortgage agreement with Lender X includes a due-on-encumbrance clause, Lender X could accelerate the debt, requiring Mark to pay off the entire commercial mortgage immediately. Lender X's concern would be that the additional debt makes their primary security interest riskier.

• Example 3: Property owner installing solar panels with a lien

  Suppose Emily has a mortgage on her house from Credit Union Z. She decides to install a new solar panel system, and the solar company offers financing that involves placing a lien on her property until the system is fully paid. If Emily's mortgage with Credit Union Z has a due-on-encumbrance clause, the Credit Union could demand full repayment of her mortgage if she did not obtain their consent before allowing the solar company to place a lien on her home. The Credit Union wants to ensure they are aware of and approve any new financial claims that could affect their ability to recover their loan in case of default.