Following a death, family members often begin the challenging task of going through their loved one's home - cleaning, organizing, selling, passing on and discarding the items that accumulate over a lifetime. But what about the house and real estate itself?
An effective and timely transfer of homeownership is important after the owner's death. This is especially true because the home is often the largest asset of the estate.
If the home is a probate asset, there may be long delays before the home can be sold. In the meantime, the estate is saddled with mortgage payments, HOA fees, insurance, utilities, upkeep and other costs until the court allows the home to be sold. Months may go by while these expenses erode the value of the estate and beneficiaries wait for the probate process to conclude.
Probate is a process in which a person's last will and testament is presented to a court to determine:
- Whether the will was validly created.
- Who is entitled to carry out the terms of the will (often known as the personal representative or executor).
- Who is entitled to receive assets under the will.
During the probate process, the personal representative will identify the estate's assets, pay the estate's debts and distribute any remaining assets to the beneficiaries designated in the will. In order to accomplish these tasks, the personal representative may sell assets or transfer ownership of assets to the beneficiaries.
Probate rules and procedures are determined by state law. The process and rules of probate vary from state to state and sometimes even from county to county. Generally, there are many potential downsides to probate:
- The probate process can be expensive and typically requires the assistance of an attorney.
- Probate almost always involves some degree of involvement and oversight of the judicial system into the deceased's personal assets. A court's power to oversee the probate process can vary from minimal supervision to closely held control depending on state laws and the terms of the deceased's will.
- The probate process can require the participation of multiple family members who often don't see eye to eye or who feel unfairly treated by the deceased.
- The courts and the judicial process move slowly. The process of getting a will through probate can take an extended amount of time, typically anywhere from several months, or in the case of contested probate proceedings, several years.
- Probate often requires family issues and finances to be publicly disclosed. This may be due to contested hearings if the will is challenged. Even in uncontested probate proceedings, many states have laws that make probate filings public record.
As we previously discussed, it can be expensive and time consuming to maintain a loved one's home throughout the probate process. Therefore, it is wise to consider non-probate methods such as revocable living trusts, transfer-on-death deeds and life estate deeds to transfer ownership of a home.
Let's briefly define each of these non-probate options:
- A revocable living trust is a special type of trust that is created to operate both during a person's life and after their death. The person creating the revocable trust is called the grantor. While the grantor is alive, they retain the power to alter or change the provisions of the trust. When the grantor dies, the trust becomes irrevocable. Title to a home may be transferred to a revocable trust.
- A transfer-on-death (ToD) deed is a type of deed that automatically transfers property to a designated beneficiary upon the death of the property owner. The transfer occurs without the need for probate, facilitating the disposition of the property after the owner's death.
- A life estate deed is a deed that transfers ownership of property to a third party but allows the original owner to retrain the right to use the property for their lifetime. After execution of the life estate deed, the original owner (legally known as the life tenant) retains all rights and responsibilities of an owner except that they cannot sell or transfer the property. Upon the original owner's death, the property passes automatically to the person designated in the life estate deed (legally known as the remainderman).
These non-probate solutions may sound like a simple way to avoid the time and expense of including a home in probate. However, a mortgage or home equity loan on the property can complicate the planning process.
Very generally, a security interest is an interest in property - real estate or otherwise - that secures repayment of a debt. A common example of a security interest is a real estate mortgage or deed of trust on a home. The borrower pledges the property as collateral for securing repayment of the mortgage loan to the lender. If the borrower fails to fulfill its obligations under the mortgage or deed of trust, the holder of the security interest can repossess the home and sell it to recoup any losses.
Most homeowners have a mortgage or security interest on their home. This means that the holder of the mortgage has an interest in the property for the duration of the loan. A revocable trust or ToD deed does not impact the lender's security interest - the loan must still be paid and the security interest remains attached to the home.
When a person dies, leaving behind a home with an outstanding mortgage, the mortgage company still expects to be paid, leaving the decedent's heirs or beneficiaries with the task of managing the home and its expenses.
Many heirs or beneficiaries choose to refinance the mortgage under their names. This may not be simple, however, because the lender may require the new borrowers to jump through hoops if the home is not individually owned by the borrowers. Lenders may also simply decline the loan application. Most lenders will decline a loan application if the home is subject to a life estate deed.
Let's discuss the complications and planning restrictions in transferring ownership of a home that is subject to a mortgage.
Question 1: Is probate the only option?
No. Probate is never the only option - at least not with a comprehensive estate plan. And for most people, probate is an option to be avoided. A qualified Legacy Plan Network Attorney can help you identify your options for transferring ownership of your home outside of probate. As previously outlined, a revocable trust, ToD deed and life estate deed are all non-probate methods of transferring ownership of real property.
Question 2: Does trust ownership or ToD deed trigger the due-on-sale clause?
The short answer is probably not.
Most home mortgages contain acceleration clauses. An acceleration clause is a term in a loan agreement that requires the borrower to pay off the loan immediately under certain conditions, such as when the borrower is behind on payments or in foreclosure.
Some mortgages also contain a specific type of acceleration clause known as a “due-on-sale” clause. A due-on-sale clause requires acceleration of the loan if the borrower sells or transfers the real property before the mortgage has been paid in full. These clauses are intended to protect the lender's security interest in the mortgage.
Due-on-sale clauses for real property mortgages are regulated by the federal Garn-St. Germain Depository Institutions Act of 1982. Under this Act, a lender may not enforce a due-on-sale clause when:
- The property is transferred into a revocable living trust in which (1) the borrower is and remains a beneficiary; and (2) which does not relate to a transfer of rights of occupancy in the property.
- The property is transferred to a relative following the borrower's death.
This means that the due-on-sale clause is not triggered when a person dies if the property is transferred to a relative, whether that transfer occurs as a result of an heirship proceeding, probate or non-probate method. But be careful - this protection applies only when the new owner is a relative of the deceased.
Provided that all conditions are met, the Garn-St. Germain Act also permits a homeowner to place real property into a revocable living trust without triggering a due-on-sale clause.
Question 3: What happens to the mortgage when the borrower dies?
When a homeowner dies before the mortgage loan is fully paid, the lender still has a valid security interest in the property and is entitled to the balance owing on the loan. The estate is obligated to pay the balance of the mortgage (to the extent that it is able), not the deceased's heirs or beneficiaries.
To pay off the mortgage, the estate has several options:
- The personal representative can pay off the mortgage with estate funds, allowing the beneficiary to inherit the home free and clear.
- The beneficiary may assume the mortgage, making regular mortgage payments.
- The beneficiary may refinance the mortgage.
- The beneficiary may choose to sell the home to pay off the mortgage and collect any remaining equity.
- If the property does not have sufficient equity to pay, the estate may allow the lender to foreclose on the mortgage.
Question 4: What kind of options and actions can be taken to plan ahead to transfer a home that is subject to a mortgage or home equity loan?
In considering how you wish to dispose of your home after your death, consider the following issues:
- Who should receive the property?
- Should your beneficiaries receive the property subject to the mortgage or free and clear?
- If your estate does not have sufficient funds to pay off the mortgage, what arrangements should be made to ensure that there are sufficient funds to maintain the home and its expenses?
- Is there a benefit to keeping your home out of probate? If so, what is the best method to accomplish that?
As discussed, there are several non-probate methods for keeping your home out of probate, allowing the home to pass directly from you to your beneficiaries following your death.
You may also need to consider providing a way for your beneficiaries to afford not just the mortgage payments, but also the upkeep, property taxes, homeowners insurance and homeowners association (HOA) fees. Additional funds for homeownership costs may be provided by leaving your beneficiaries other liquid assets (such as the cash in a payable-on-death bank account) or by naming them as a beneficiary on a life insurance policy. You may also consider funding a trust with life insurance.
Transferring ownership of your home following your death can be complicated, especially if you have an outstanding mortgage, but there are options to make the process easier and more efficient. The seamless transfer of your real estate can be accomplished by working with an experienced Legacy Plan Network Attorney. All too often, people fail to implement a plan for their assets following their death because they lack critical information, feel that the necessary steps are too overwhelming, or because they don't know where to begin.
By working with Legacy Plan, you can be assured that your end-of-life documents are in order. A Legacy Plan Network Attorney will explain your options and help you to identify the right plan for you and your family.