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Author: Brenton McWilliams

What Happens When Real Estate in an Estate or Trust has a Mortgage?

In estate or trust administration, the deceased’s residence is often the largest asset of the estate. A mortgage on the residence or other property of the estate can be a source of frustration or stress for the heirs or spouse of the deceased borrower. I put together the following blog post to provide helpful information (and to clear up misinformation) about inheriting estate property that is subject to a mortgage.

If I inherit estate property with a mortgage, can the bank call the entire amount of the mortgage due?

It depends. A brief discussion of the “due on sale” clause is necessary to provide background context for the answer to the question. Most federal mortgages contain a due on sale clause, a clause to prevent the borrower from transferring any interest in the mortgaged property.

A due on sale clause provides that if any interest in the property is transferred, without the lender’s consent, the lender is given the option to accelerate the loan and declare the entire amount immediately due. Typically, after the acceleration, foreclosure is the next step in the event the borrower cannot pay off the entire loan balance. Note that the transfer of the property interest would still be subordinate to the lender’s mortgage encumbrance on the property. In other words, the mortgage still attaches to the property after the transfer. Therefore, the lender would retain the capability to foreclose the mortgage on the property notwithstanding the transfer of the borrower’s interest in the property.

As an example of a due on sale clause, the Alabama Single Family Fannie Mae/Freddie Mac Uniform Instrument contains the following:

18.  Transfer of the Property or a Beneficial Interest in Borrower.  As used in this Section 18, “Interest in the Property” means any legal or beneficial interest in the Property, including, but not limited to, those beneficial interests transferred in a bond for deed, contract for deed, installment sales contract or escrow agreement, the intent of which is the transfer of title by Borrower at a future date to a purchaser.

If all or any part of the Property or any Interest in the Property is sold or transferred (or if Borrower is not a natural person and a beneficial interest in Borrower is sold or transferred) without Lender’s prior written consent, Lender may require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if such exercise is prohibited by Applicable Law.

If Lender exercises this option, Lender shall give Borrower notice of acceleration. The notice shall provide a period of not less than 30 days from the date the notice is given in accordance with Section 15 within which Borrower must pay all sums secured by this Security Instrument. If Borrower fails to pay these sums prior to the expiration of this period, Lender may invoke any remedies permitted by this Security Instrument without further notice or demand on Borrower.”

On an individual’s death, their property is transferred to the heirs under a will or the heirs at law through intestate succession. Therefore, in the case of the death of the borrower, the results of a strict application of the due on sale clause could result in an extreme hardship on the heirs inheriting the property. If not for other laws, the death of the borrower would result in an involuntary transfer of the inherited property to the deceased borrower’s heirs which would trigger the due on sale clause and allow the lender the option of calling the entire amount of the deceased borrower’s debt immediately due and payable. Following the triggering of the due on sale clause, the heirs inheriting the property would be left with the, often unfeasible, choice of completely paying off the entire balance of the mortgage out of pocket or refinancing the inherited property in the name of the heir (or heirs) to pay off deceased borrower’s loan. However, congress addressed this issue as part of the Garn St. Germain Act.

For mortgages included in the act, the Garn St. Germain Act provides prohibits lenders from enforcing a due on sale clause in several circumstances included within the act. A couple of these apply particularly in the context of an estate or the death of the borrower including the following:

(3) a transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety; 

(5) a transfer to a relative resulting from the death of a borrower;

 (6) a transfer where the spouse or children of the borrower become an owner of the property;

 These prohibitions apply to a real property loan (as defined by the act) “secured by a lien on residential real property containing less than five dwelling units.”

 To summarize, in addition to other instances specified in the act, in applicable situations, a lender is prohibited from enforcing a due on sale clause if the transfer is by operation of law to a joint tenant following the death of the borrower, the transfer is to a relative through an estate or other transfer as a result of the death of the borrower, or the transfer results in the spouse or children of the borrower owning the property.

 Do I have to make mortgage payments on inherited estate property?

If payments on the mortgage are not made, the inherited property could go into foreclosure. Note that following the death of the borrower, the mortgage stays in place as an encumbrance on the inherited property until it is paid off. The mortgage is not extinguished by the death of the borrower. Although the inherited property may be an asset of an estate, the mortgage remains in place. The personal representative of the estate may control the inherited property as part of the estate administration subject to the mortgage. The estate, heirs or beneficiaries must continue to make payments on the mortgage or the inherited property may go into foreclosure.

Can I communicate with the lender after inheriting mortgaged estate property?

In recent years, the consumer financial protection bureau (CFPB) has passed rules allowing mortgage lenders/servicers to communicate with “successors in interest” to mortgaged property to the same extent as if the successor in interest was the initial borrower.  

The rules set up a procedure for a servicer to confirm a person’s status as a successor in interest to the inherited property. Servicers are required to provide, on written request from a successor in interest, the documents needed to confirm the requestor’s status as the successor in interest to the inherited property and are required to have policies for communicating with the successor in interest regarding the confirmation of their identity. The successor in interest definition used in the communication rules for servicers tracks the definitions used in the Garn St. Germain Act set forth above.

If you have questions about estate administration in Alabama including estates containing mortgaged property, please call (251) 215-9275 or write me on the contact page to schedule an appointment to discuss how I can help.