What Happens If You Inherit A House With A Mortgage?
The death of a loved one is an incredibly difficult time. Not only are you emotionally drained, but after the funeral you have the added anxiety of sorting through legal documents, financial information and the last will and testament of the deceased. You want to make sure you take care of any financial loose ends, and that can turn into an overwhelming task.
One obstacle some may have to deal with after the death of a loved one is a mortgage. If you already have a home loan payment of your own, you might not be able to afford to take on another. So, what happens if you inherit a house with a mortgage, and what do you do next? We’ve got a few tips and things to consider when managing an inherited mortgage.
Can You Inherit A House With A Mortgage?
Yes, you can, in one of two ways: as the beneficiary of a trust or through the legal process known as probate.
After the death of a loved one, referred to in legal proceedings as the decedent, their assets will go through a process called probate if they left a will or died intestate (without a will).
Probate is a legal process used to properly distribute an individual’s assets to their heirs as outlined in their will or according to state law if they didn’t leave a will. The estate, or all the decedent’s property, including real estate, is managed by the executor of the estate while the estate is in probate.
Because the deceased individual’s debts still need to be paid off, their remaining assets will need to be sold to pay lenders what they are owed. This could come in the form of physical or liquid assets, depending on the size of the estate of the individual.
When all debts have been settled, the remaining assets are distributed among the heirs. In many cases, this could mean inheriting their home, even if that home still has an outstanding balance on the mortgage.
As A Trust Beneficiary
Property can also be passed to a beneficiary through a trust created by the decedent. The big difference between the two is that a will must be probated, which can be a lengthy legal – and public – process. As part of their elder planning, the decedent – sometimes called the grantor – may prefer to bypass probate and set up a trust, either an irrevocable or a living trust. Setting up a trust means that the beneficiary of the trust becomes the owner of the property automatically when the grantor dies.
Inheriting A House With A Mortgage: Next Steps
You’ll have a few options to consider for what you should do next if you’ve inherited a house with a mortgage. You could either sell the home to pay off the mortgage and keep any remaining money as your inheritance, or you could keep the home. If you keep the home, you’ll need to either continue making payments on the loan or use other assets to pay the mortgage off.
Let’s take a look at what you should consider when you’re planning what to do next.
1. Ask A Professional For Advice
Contact an attorney if you have any specific questions or just feel completely lost; they can help you sort out specific questions. Laws differ from state to state, and we all know how difficult legalese can be to read. Don’t be afraid to ask for help if you need it, and – most importantly – don’t sign or agree to something you don’t understand.
2. Do The Math
In order to properly evaluate the financial implications of an inheritance, you’ll need to figure out the decedent’s home equity, the value of the home, the remaining balance on the home loan, the monthly mortgage payment, the monthly costs of managing the home, and the condition of the home, particularly the cost of any major repairs.
You might consider consulting a listing real estate agent to get a good idea of what the home is worth in the current market and how quickly it’s likely to sell. Even if you’d prefer to live in the home, reliable information about how much you could earn from a sale is good to have. Likewise, consider how much you could earn if you chose to rent the property out.
The executor of the estate should have access to all the decedent’s bank accounts and bills for the home and can share with you how much you can expect to pay monthly for recurring items like energy bills and other utilities. You also may want to have a home inspector take a look at the home to give you an idea of what types of repairs the home needs.
3. Consider Your Tax Situation
One of the main benefits of inheriting a home versus receiving ownership of it during the decedent’s lifetime is that an heir gets a step up in the cost basis of the home. That means that if you choose to sell the home immediately, you’ll owe very little in capital gains taxes.
If you decide to stay in the home, the value of any capital improvements you make to the home will be added to your cost basis as well.
4. Gather All The Mortgage Documents
Hopefully, the homeowner kept a file of their mortgage documents. At the very least, try to find a document saying who services the mortgage. You, or your family attorney, will need to call the servicer to notify them of the death. Chances are they’ll want a copy of the death certificate before you can move forward. After verifying the death and updating documents, the servicer will then be able to tell you how much is left on the mortgage and how much the monthly mortgage payment is. At this point, you’ll have the information you need to decide how to deal with the remainder of the mortgage.
You’ll also want to ask if the borrower had mortgage protection insurance on their home. If they did, this could help simplify the complicated process of dealing with a mortgage after their death. If they passed before their mortgage was paid off, the insurance company will cut a check to pay the remainder of the mortgage, and the home will be paid off.
5. Review The Mortgage Loan Documents Carefully
Take the time to review the terms of the mortgage note carefully while making sure mortgage payments are made uninterrupted.
Type Of Mortgage
Figure out if the mortgage on the property you’ve inherited is a primary mortgage or a reverse mortgage. With a reverse mortgage, the amount of equity advanced to the original homeowner becomes due upon their death. However, you can refinance the mortgage loan to pay off the balance due.
If the mortgage is the primary mortgage, you can simply continue making payments – if the terms are favorable and the interest rate lower than what’s available at the time of the inheritance. If you can get better terms now – especially if you want to cash out some of the equity you’ve inherited in the home to make needed improvements – you might want to consider a cash-out refinance.
Due On Sale Clause
You will likely encounter a due-on-sale clause – also known as an alienation clause – in your inherited mortgage note. This clause reads that if the original borrower transfers ownership of the property to a third party – for example, to an LLC – the mortgage lender can demand repayment of the loan in full. However, most states follow the federal government’s guidelines against applying this clause in the situations of a transfer among spouses or their children and when the heir or beneficiary inherits the mortgage.
Be aware that you may also read what’s known as the acceleration clause, which makes the remainder of the loan due should the borrower – now the beneficiary or heir – default on the mortgage. If you’re the beneficiary of a trust, you become responsible for mortgage payments immediately upon the death of the trust’s creator. During probate, the estate’s executor is responsible for making mortgage payments.
6. Start Making The Loan Payments
You’ll need to keep mortgage payments current. Otherwise, the mortgage lender may bring a foreclosure action. Once in foreclosure, the home and all of its remaining debts will be turned over to the mortgage company.
In the event a home is left to an heir via a will, the heir(s) – whether there are one or more people – is now responsible for the mortgage. It’s important that you establish who’s responsible for the loan, because this person (or group of people) will work with the lender to get details and information about the mortgage.
7. Pay The Mortgage Off
If you can pay the mortgage off completely, that’s another option (and probably the easiest) to deal with an inherited home loan. With the house completely paid off, you can then keep the property, maybe lease it out or simply sell the home. Either way, paying the mortgage in full frees the property from a lender and allows you to do what you please with the home.
Inheriting A House With A Mortgage FAQs
What if the decedent had a reverse mortgage on the home?
If you plan to keep the home, either as your primary residence or as an investment property, you can essentially refinance the debt by getting a new mortgage to pay off the reverse mortgage. If you plan to sell the home, you can make payments on the reverse mortgage until you’re able to sell the home, then pay off the balance of the loan.
What if siblings inherit a home with a mortgage together?
It really depends, of course, on the relationship among family members and the terms of the trust or the will. The most important responsibility is to keep mortgage payments current as agreements are worked out among multiple heirs. If you anticipate inheriting your parents’ home with your siblings, it’s best to talk about it during your parents’ lifetime and include those stated preferences in legal documents.
The easiest course is to sell the home, pay the loan off and split the proceeds. But often, one sibling intends to live in the home and – if the others agree – that sibling can refinance the mortgage. If they can qualify – and the appraisal value is sufficient – to get approved for a mortgage, that sibling can use the proceeds of the loan to buy each sibling’s share.
What are the tax implications of inheriting a home with a mortgage?
There are many types of taxes to consider. When you inherit a property, you assume a cost basis equal to the fair market value of the home at the time of the death. From a capital gains tax point of view, that’s generally favorable. If you rent the property out, you’ll enjoy the many tax advantages of real estate investment, like being able to deduct the cost of repairs and maintenance.
You’ll also want to consider how much you’ll be paying in property taxes. The 2017 Tax Cuts and Jobs Act placed a $10,000 limit on the combined amount of state income tax and local property taxes that can be deducted from your federal income taxes.
The Bottom Line
Inheriting a house from a loved one can feel like a gift or a burden, depending on the circumstances. Family and financial decisions can be particularly difficult to make while mourning a recent death. It’s always best to plan ahead and get the professional guidance you need.
If you decide to keep the home you’ve inherited and continue making payments on the loan, now might also be the right time to explore your mortgage refinancing options.