The Wealth AdvisorContributor
April 27, 2021
The following information was developed by an independent third party. The opinions are of the listed author and are independent from and not necessarily those of RJFS or Raymond James. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. Raymond James Financial Services, Inc. does not provide advice on mortgages.
Understanding what happens to your debt when you die is an important part of estate planning—and you don’t have to be rich to have an estate. Everything you own and owe makes up your estate. For many people, that includes a house with a mortgage.
The median housing-related debt of a 65- to 74-year-old borrower with a first mortgage, home equity loan and/or home equity line of credit was $100,000, according to the U.S. Census Bureau’s American Housing Survey in 2019, the latest results available. For homeowners 75 years and older, it was $75,000.
State and federal laws determine what happens to the house and the mortgage when the owner dies. The owner also has a say, as long as they do some basic estate planning—like creating a will or trust, designating beneficiaries and possibly buying a life insurance policy.
Your Debt Doesn’t Die With You. Here’s Why.
When you die, all your liabilities and assets—including your house—become part of your estate, which someone then has to settle. An important part of this process is taking inventory of everything you own, and figuring out who gets what among heirs and creditors ahead of time.
If you have a will, then you’ve already chosen an executor to handle this task. If you die without a will or trust, then your state’s probate court will appoint someone to settle your estate: typically a spouse, an adult child or closest relative.
Whomever this person ends up being, they will need to find out who is named on the deed, who holds the title to your home and whether you’ve established a living trust or transfer-on-death deed to keep your home out of probate. This will save your heirs money and can simplify the property’s transfer.
If you’re the sole owner and don’t have a living trust or transfer-on-death deed, but you do have a will passing your home to an heir, for example, here’s what would happen next.
What Happens to a Mortgage Once the Home Transfers to an Heir?
If your will names an heir to your home, that person will not have to take over your mortgage, as long as they are not co-borrowers or co-signers on your loan. However, federal law does allow your heirs to take over the mortgage.
If you leave your mortgaged home to your daughter, for example, the mortgage servicer must honor her request to become the new mortgagee (the borrower). She does not have to qualify and demonstrate an ability to repay the loan. This rule covering the assumption of a mortgage also applies after the death of a spouse, though many spouses are often co-borrowers on a mortgage and co-owners of a home already.
Even though mortgages have a due-on-sale clause that normally requires the mortgage to be repaid in full when the property’s ownership changes, it doesn’t apply when an heir takes over.
Helping Heirs Afford the Mortgage
The lender will still be able to foreclose if the assumed heir stops making payments. You may need to provide a way for the heir to afford not just the mortgage payments, but also the upkeep, property taxes and homeowners insurance. If the home belongs to an association, staying current on homeowners association (HOA) payments is also imperative.
You can provide these funds by leaving your heir other assets (such as the cash in a payable-on-death savings account) or by naming them as a beneficiary on a life insurance policy. You could also consider funding a trust with life insurance.
What Happens to a House When the Owner Dies With Other Debt?
If you die with other debts that can’t be repaid from your estate, state law may require the executor to sell your house to help repay those debts. If the proceeds from selling the home exceed the debts owed, then whoever was chosen to inherit your house will get the excess.
Again, life insurance can help here. It can repay your debts at death so your heir can inherit your home.
Remember, your estate does not have to pay off your mortgage. Since your mortgage is secured by your home, the mortgage servicer can foreclose and sell the home to get back the money owed.
What to Do as Heir of a Home With a Mortgage
If you’re an heir or an executor of an estate (or both), you’ll need to deal with the house and the mortgage when the homeowner dies.
Keep Making Mortgage Payments
It usually takes several months to wrap up someone’s affairs after they die. If you don’t want the home to fall into foreclosure while the estate is being settled, it’s important to keep making mortgage payments. These payments might come from the estate, or from an account that the deceased designated as payable on death to the heir. Payments could also come from life insurance proceeds.
Tip: Payable-on-death accounts do not have to go through a lengthy probate process before heirs can access funds. The heir or heirs designated as the account’s beneficiaries will be able to use the funds in the account within days of providing a death certificate to the bank. That said, if the estate has other debts besides the mortgage, creditors may have a claim to assets in a payable-on-death account.
Pay Off the Mortgage
Paying off the mortgage after the owner dies isn’t a decision to rush into. A mortgage is usually a low-interest loan, and the estate’s other assets or the proceeds of a life insurance policy may be better put to other uses. Some people buy mortgage protection insurance to pay off the loan when they die, but experts usually say premium dollars are better spent on conventional life insurance.
Refinance the Mortgage
An heir who cannot afford the mortgage but wants to keep the home may be able to refinance into a lower monthly payment. Here are some possibilities:
- Ask the mortgage servicer for a loan modification
- Refinance into a longer-term loan
- Refinance into a lower rate
Sell the Home
If the home has appreciated since the deceased purchased it or last took out a mortgage against it, then selling the home may be a good choice, especially if the home has more than one heir.
If the home is worth less than the mortgage balance, the executor or heir will not be able to sell the home, unless the lender agrees to a short sale. This means they will accept a sales price below what the deceased owed on the mortgage. The heir can keep making mortgage payments until the home has positive equity and then sell it, or allow the lender to foreclose.
Let the Lender Foreclose
If the deceased was the sole borrower and home resident, and there’s not enough home equity to make selling worthwhile, the heir or executor may decide to let the lender foreclose on the home.
However, if an heir has already taken over the loan, or if the loan had a co-borrower or co-signer who is still alive, a foreclosure will have serious consequences for that person’s credit. This includes making it difficult to obtain new credit or buy another home for at least a couple of years.
If the deceased had a reverse mortgage and does not have a surviving spouse living in the home, the lender will foreclose and sell the home to repay the debt, unless the heirs pay off the reverse mortgage. As long as the reverse mortgage is a home equity conversion mortgage (HECM), the heirs have the option to repay the reverse mortgage balance or 95% of the home’s appraised value, whichever is less, if they want to keep the home.
If a HECM foreclosure sale doesn’t fully pay off the loan, it doesn’t matter because an HECM is a non-recourse loan. The estate will not have to pay the difference. In a regular foreclosure, the estate could be responsible for a deficiency unless the home is in a non-recourse state.