Transferring mortgaged property into a trust

Many estate and financial plans call for you to transfer your home ownership into a trust. Every family situation is different, and various types of trusts are available.

If you own your home free and clear, transferring it into a trust is simple and straightforward. Of the about 131 million homes in the United Staes, more than 30 million of them are mortgage free. That 23% of the home-owning population will have no trouble transferring these properties into a trust.

But for 77% of the population with mortgages on their properties, the elephant-in-the-room question is what happens with the bank if you transfer your mortgaged property into a trust. Virtually all mortgages in the U.S. have a “due-on-sale” clause to protect the bank from property transfers without their permission. Historically this was a problem for people transferring the property into a trust without paying off the mortgage first.

A due-on-sale clause is also called the “acceleration” clause. This clause is a term and condition of the mortgage that requires the borrower to repay the lender in full if the property is sold or conveyed to another person. And this clause can be triggered even if you only convey a portion of the interest.

Historically, mortgages did not contain a due-on-sale clause. But in the 1970s and ’80s, interest rates rose sharply, and home buyers had difficulty qualifying for a new mortgage. In 1970, mortgage rates were almost 8%, and by 1981, they reached a high of more than 18%. 

During that time, many buyers tried to assume the current low-interest mortgage on the property rather than take out an exorbitantly high-interest mortgage. And with extremely high-interest rate mortgages, many buyers could not qualify because their income and liabilities did not meet the debt-to-income ratio at the high payment rate on those new mortgages.

As more and more buyers started assuming the older low interest rate mortgages, banks lost out on the business of issuing new high interest rate mortgages. So, in the 1970s, lenders and banks began using mortgages with due-on-sale clauses.

The clause had language like, “If all or any part of the property herein is transferred without the lender’s prior written consent, the lender may require all sums secured hereby immediately due and payable.”

From that point forward, most low interest rate mortgages were no longer assumable, and new buyers were forced into getting a high interest mortgage from the bank.

But the due-on-sale clause created problems with heirs who inherited property and spouses awarded the house in a divorce settlement. According to the typical due-on-sale clause, both transfers triggered the acceleration clause, and the banks could insist on the old mortgage being paid in full from the heirs or divorced spouses.

But what about transferring your home property into a revocable living trust? The banks could trigger the acceleration clause at that time even if you were simply transferring your house into your revocable living trust. Since the trust is a separate entity from you, technically, you were transferring an interest, and that was all the bank needed to exercise the due-on-sale clause.

This was a serious blow to strategic estate and tax planning strategies.

The Garn-St Germain Depository Institutions Act, signed by President Ronald Reagan in 1982, made several substantial changes affecting lenders, borrowers and property owners with mortgages.

The legislation was intended to protect borrowers, lenders and the housing market. The act introduced adjustable-rate mortgages and removed interest rate limits on banks and savings and loans.

But, importantly for financial planning, it prohibited lenders from exercising their due-on-sale clauses in a number of situations.

In 1982, times were bad for homebuyers, lenders and the housing industry. Many mortgage lenders were going out of business. Home mortgages were hard to get. The residential real estate market was grinding to a halt.

There was quite an uproar among homebuyers and eventually Congress, as the banks forced buyers into higher-rate mortgages. And ex-spouses and heirs were forced to pay off mortgages on transfers of property.

Under the Garn-St Germain Depository Institutions Act, lenders cannot exercise a due-on-sale clause and accelerate a mortgage payoff under the following circumstances:

• Junior mortgages — The creation of a lien or other encumbrance subordinate to the lender's security instrument that does not relate to a transfer of rights of occupancy in the property.
• Household appliances — The creation of a purchase money security interest for household appliances;
• Death of joint tenant — a transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety;
• Lease — the granting of a leasehold interest of three years or less not containing an option to purchase;
• Give to a relative upon death — a transfer to a relative resulting from the death of a borrower;
• Spouse and children — a transfer where the spouse or children of the borrower become an owner of the property;
• Divorce, separation, or settlement — a transfer resulting from a decree of a dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement, by which the spouse of the borrower becomes an owner of the property; or
• Transfer to trust — a transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property.

So, under these circumstances, the lender cannot call the loan due and cannot require that the mortgage be refinanced.

One purpose of the act was to slow down the growing number of foreclosures in the U.S. The act made it illegal for a lender to exercise the due-on-sale clause in certain situations and for certain real estate types. The act covers residential real property containing less than five dwelling units. This included single residences, most condos, townhomes and residential manufactured homes.

Lenders are no longer allowed to exercise due-on-sale clauses for many unfair situations.

For example, a homeowner often gets a home construction loan that is collateralized by a second lien on the home. It is unfair for the original lender to declare the original mortgage in default for just getting a construction loan.

Before the act, the lender could accelerate the mortgage when you inherited a house from a parent. This is now prohibited under Garn-St Germain.

And lenders can no longer accelerate the mortgage if the borrower transfers the house to their spouse or children. Nor can the lender trigger the due-on-sale clause for a house awarded in a divorce.

But most importantly for financial planning, lenders are prohibited from calling the mortgage due when the owner transfers the house into an inter vivos trust where the borrower is a beneficiary of the trust. This includes revocable living trusts.

It is important to remember that none of these situations wipe out the mortgage. The mortgage obligations accompany the transfer and become the new owner's responsibility, and the original mortgagee also remains liable.

For financial and estate planning, you can now transfer your house ownership into a revocable living trust with no fear of the lender accelerating the mortgage. You, of course, are still obligated to make the payments, but you no longer have to pay off the mortgage upon transfer.

No. A revocable living trust is a private and confidential agreement between the person setting up the trust – the grantor, and the person who manages the trust – the trustee. The grantor has equitable title to the assets, while the trustee has legal title.

This trust agreement does not need to be recorded to be effective.

Transferring real property into a revocable living trust is the same process as transferring real property to any other individual, business or entity. The grantor places the mortgaged home into the trust by properly executing a deed from the current owners to the trust. When transferring or accepting a property by deed, most people choose a warranty deed and a title search to ensure ownership of the correct parcel.

However, here you are transferring the property from yourself to your trust, and many grantors simply execute a quit claim deed. Local counties and municipalities recognize this conveyance as a family matter and charge only a recording fee for the deed, not the customary real estate transfer taxes. And while there is usually no legal requirement to record the deed, most people do so to preclude any future claims in the chain of title.

This depends upon your mortgage agreement and your state law. While the Garn-St Germain prohibits the bank from accelerating the mortgage, the language in your mortgage customarily speaks toward your obligations when you transfer an interest in the property.

The title to the property changes when the deed is executed. And while the trust may be obligated to pay the mortgage payments according to the trust documents, the bank does not relieve the original borrower from their obligations. Knowing that, some people just keep making payments on the property as if there were no change in ownership.

However, the more proper way is to notify the bank that the property has been transferred into a revocable living trust for estate planning purposes. This type of transfer is prevalent, and banks have straightforward paperwork to note the transfer.

No. Trusts are private and confidential documents. While some trusts are only a few pages, many are complex documents with sensitive financial and personal information. For example, a trust will show the beneficiaries, how much they will receive and other personal information. The bank does not need to review the trust document.

Most banks have you complete a simple certificate of trust. This is usually a two-page document from the bank that lists the general information about the trust. The bank will ask for the name of the trust, your Social Security number or tax ID number and a list of the current trustees. Your bank may ask to see the trust's first and last pages to verify the trust's name, the date of the trust and that the document was properly notarized.

Sometimes a bank employee will ask for the entire trust. If that happens, usually, a manager will explain that a certificate of trust is sufficient. If they persist, you should consider having your trust attorney call them.

A revocable living trust can be a powerful tool in your family’s estate planning. Thanks to the Garn-St Germain Act, you can transfer your house into your revocable living trust without the concern of having to pay off the mortgage.

For peace of mind and your family's financial well-being, your next best step is to have a will and estate plan. By acting now, you ensure your assets will be distributed to your children and stepchildren according to your wishes.