California Real Estate Salesperson Exam Practice - Question 67

Question

When a property is sold during a tight money market and the existing loan contains an alienation clause, which of the following is most likely to occur?

Selections

A. Buyer will assume the loan on existing terms

B. Seller would refinance the property before the sale

C. Buyer will take title "subject to" the loan

D. Buyer will secure new financing

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Answer: D

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5 Keys Summary

• An alienation clause (or due-on-sale clause) gives the lender the right to demand full payment of the outstanding loan balance immediately upon the transfer or sale of the property.

• Because the loan is subject to an alienation clause, the existing lender is likely to enforce it when the property is sold, preventing the buyer from assuming the existing (and likely lower-rate) loan.

• In a tight money market, lenders generally prefer to enforce alienation clauses to accelerate payment on older, potentially low-interest loans, allowing them to reinvest the capital in new loans at the current, higher market interest rates.

• The alienation clause also prevents the buyer from taking title "subject to" the existing loan, as this action still constitutes a transfer of the security property, triggering the lender's right to accelerate the debt.

• Since the existing loan must be paid off due to the enforcement of the alienation clause, the buyer must obtain new financing to complete the purchase, even if new loans in a tight money market feature escalating interest rates and stricter terms.

Explanations

When a property is sold and the existing loan includes an alienation clause (also known as a due-on-sale clause), the lender has the right to demand full repayment of the loan if the property's title is transferred to a new buyer.

In a tight money market, interest rates are typically high, and lending standards are stricter, making it more challenging and expensive to obtain new loans. However, the presence of an alienation clause fundamentally changes the situation:

For the sale to proceed, the existing loan must be paid off. If the buyer does not have enough cash to pay the full purchase price, they will be forced to secure new financing (Option D), even if the terms are less favorable due to the tight money market. This becomes the most probable path to completing the transaction.

The lender, in a tight money market, is motivated to have the existing (likely lower-rate) loan paid off so they can issue a new loan at current, higher interest rates.

Therefore, the lender will almost certainly enforce the alienation clause, preventing the buyer from simply assuming the old loan (Option A) or taking title "subject to" the loan (Option C) without triggering a default.

The seller is also unlikely to refinance at a higher rate before the sale (Option B) unless absolutely necessary, as it would increase their costs.

Concepts Definitions

• Alienation Clause (Due-on-Sale Clause): A provision in a mortgage or deed of trust that gives the lender the right to demand immediate repayment of the entire loan balance if the borrower sells or transfers title to the property without the lender's prior permission.
• Tight Money Market: An economic condition characterized by high interest rates, strict lending standards, and limited availability of credit, making it difficult and expensive for borrowers to obtain loans.
• Loan Assumption: A process where a new buyer takes over the existing mortgage loan and its terms from the seller. An alienation clause typically prevents this without lender approval.
• Subject To Mortgage: A method where a buyer takes title to a mortgaged property and makes payments on the existing loan without formally assuming it or being personally liable for the debt. The alienation clause would still be triggered, allowing the lender to call the loan due.
• New Financing: The process of obtaining a new loan from a lender to fund the purchase of a property. In a tight money market, this means accepting current, potentially higher interest rates and stricter terms.