This article discusses the complicated process of taking title to a home with a mortgage, and suggests homeowners create a revocable living trust to ensure the beneficiary of their estate is not subject to a mortgage’s due-on clause.
Who’s footing the bill?
A homeowner’s death triggers a barrage of complicated responsibilities on already-traumatized family members. When mortgages are involved, an investigation is initiated — usually through probate or by the trustee — to determine who receives encumbered property and becomes responsible for the mortgages. The probate process lasts an average of 9 months to one year in California.
So who is responsible for keeping mortgage payments current until title to the encumbered property is transferred to the successor, or beneficiary?
It depends on the deceased homeowner’s trust agreement or will, and who has the funds to maintain the mortgage. Typically, the beneficiary named to become the owner of the property is responsible for payment of the mortgage, since it is the beneficiary who is subject to loss of the property by foreclosure if payments are not made. If the mortgage becomes delinquent by more than 90 days, the lender will eventually initiate foreclosure proceedings by recording a notice of default (NOD).
The lender must be contacted as early as possible and notified of the homeowner’s death to determine the status of payments, the balance due on the loan, any due dates and other terms affecting ownership. [See first tuesday Form 415]
The living trust acts as due-on shield
The advantage of vesting property in a trustee under a revocable living trust agreement is huge for survivors, both in conveyance time and handling costs.
An individual owner of property, real or personal, creates a revocable living trust, also called an inter vivos trust, to hold title to his property for multiple reasons, primarily:
- to accommodate the distribution of the owner’s estate without resorting to probate proceedings under a will; and
- to retain the interim ability to sell, encumber, lease or remove the property from the trust vesting without the need to involve others in other unattractive estate planning title arrangements, such as joint tenancy or community property vestings.
A trust agreement functions as nothing more than a set of escrow instructions which direct the successor trustee to deed properties to named beneficiaries. Probate, on the other hand, is litigation by design, requiring service of process on heirs and courtroom actions over an extended period of time. [For more information regarding living trust vesting, see the February 2004 first tuesday article, The revocable title holding trust.]
Another advantage of the living trust arrangement when considering property encumbered with a trust deed is that transfers of title into a homeowner’s living trust vesting of his one-to-four unit principal residence are exempt from due-on clause enforcement. Not so for any other type of real estate on transfer of title to a trust vesting, a common violation of the due-on clause but typically undiscovered by the lender. [For more information regarding the due-on clause, see the December 2011 first tuesday Letter to the Editor.]
A mortgage secured by the deceased’s principal residence contains a due-on clause allowing the lender to call the loan on the death of the owner, and for the transfer of any interest in the property. However, the lender cannot call or recast a mortgage secured by the deceased’s home on the owner’s death (as is the case for all other property) if it is transferred to family members. Thus, the due-on-sale clause in the mortgage on the home is negated by the federal exemption from lender enforcement.
As mortgage interest rates begin to rise around 2014-2015, lenders will use the due-on clause to increase portfolio yields with frequencies not experienced since the very late ‘80s. The living trust vesting of the principal residence ensures the beneficiary who becomes the owner of the property will not be burdened by the lender calling the loan due. [12 United States Code §1701j-3(d)(8)]
Transactions can’t be masked by living trusts
A popular and enduring misconception is that owners can use revocable living trust vestings to avoid their creditors. This belief occasionally leads to a living trust being improperly used to mask investment or sales transactions.
Consider an investor who funds a trust arrangement, and at some point names another person as the sole beneficiary. The investor receives all benefits and earnings associated with the property.
The investor then files for bankruptcy protection, but does not include the assets vested with the trust as part of his estate. Here, the assets held in trust in which the investor has no legal interest, but from which he receives all benefits and earnings, are part of the investor’s estate since his conduct established his equitable ownership of the assets. [For more information regarding the improper use of a living trust, see the December 2011 first tuesday Recent Case Decision, Bankruptcy court recovers investor’s assets held in trust vestings.]
Thus, a trust vesting is not a debt shield or an asset preservation vesting. Creditors can reach property vested in the owner’s revocable living trust, both during the owner’s lifetime and after his death. [For more information regarding the proper use of a living trust, see the first tuesday Real Estate Finance book, Chapter 32: The revocable title holding trust.]
Real estate agents, estate planning experts
As interest rates increase in the coming years, property owners will look for the best way to avoid the burden of the due-on clause in the trust deed on their property. Agents who sharpen their knowledge of vestings will become resident experts in this aspect of property law when handling acquisitions on behalf of a buyer. [For more information regarding an agent’s role in the legal and tax aspects of a transaction, see the September 2011 first tuesday articles, Raising the bar of real estate advice and Real estate licensees and the unauthorized practice of law.]