Mortgage debt can complicate bequests of real property in ways most people haven’t considered. These complications are manageable if you have planned appropriately, but may lead to unpleasant surprises if left to chance. If you own property with outstanding mortgage debt and plan for that property to pass to a family member or other beneficiary when you pass away, it’s in the best interests of your heirs to fully explore your options and their ramifications rather than simply including that property in your will or leaving it to pass through intestate succession.
Due on Sale Clauses and Inherited Real Property
Many mortgages contain “due on sale” clauses, which escalate the mortgage balance and require full payment when the property changes hands. A due on sale clause can create significant problems for an heir who may not have the funds or available credit to pay off or refinance the mortgage.
Fortunately, federal law provides protection for some of the most common transfers upon death. For example, when the family home passes from husband to wife or parent to child through a will or intestate succession, this transfer does not trigger a due on sale clause. This protection extends to other relatives, as well. Similar protection applies when the property passes to a joint tenant or tenant by the entirety by operation of law.
When the property qualifies and the transfer falls within one of the exceptions described above, the mortgage continues in force and no immediate payoff is required. The first step toward protecting your heirs if you own real property that is subject to a mortgage will be to find out whether the property qualifies for the exception, and then to ensure that the property is held and transferred in a manner that preserves the mortgage.
Practical Considerations Regarding Bequests of Mortgaged Property
While due on sale clauses may create an immediate barrier to the acceptance of mortgaged real property, they are not the only concern. A transfer that falls within an exception to the enforceability of due on sale clauses may still prove unworkable for the heir. When the transfer is exempt from mandatory payoff, the heir essentially inherits the mortgage debt along with the property. While that’s often more workable than being compelled to pay off or refinance the mortgage debt, many heirs will not have the available income or resources to make scheduled mortgage payments.
Recognizing the possibility that real property may still be subject to a mortgage lien at the time of transfer and that the heir or heirs may not be in a position to make scheduled mortgage payments allows the property owner to better protect beneficiaries. Depending on the specifics, some options may include:
- Placing the real property into a trust, with assets sufficient to continue the mortgage payments
- Explicitly providing for other assets of the estate to be used to clear the mortgage debt
- Specifying that the real property is to be sold and any value realized distributed to heirs
- Leaving the beneficiary who receives the real property liquid assets to assist with the mortgage payments
Talk to an Experienced Estate Planning Attorney about Your Mortgaged Property
One of the greatest gifts you can offer your beneficiaries is to fully educate yourself about potential pitfalls and complications they may face when you are gone. When you speak with an estate lawyer about your will, living trust, or other estate planning tools, make sure that you address outstanding mortgage debt on any real property in your estate.