What Happens to Debt at Death
The death of a borrower changes things, but perhaps not as much as you’d think. The loan still exists and needs to be paid off, just like any other loan. But the stakes can be higher with housing debt, because family members may live in the house or have emotional attachments to it. Survivors can handle the mortgage in several ways, some of which will be more appealing than others.
Keep Making Mortgage Payments
It’s crucial to make arrangements for your monthly payments when you die. Doing so prevents the lender from applying penalty fees and starting the foreclosure process. A surviving spouse, your executor, or anybody else can make payments while they settle the estate. Automatic bill payments can do the job, too, assuming your funds are still available. Financial institutions could freeze accounts after your death, so you may need to ensure that others set up new payment methods.
Passing the Home to Relatives
Your estate is responsible for paying off debts, but real estate is unique. Under federal law, lenders must allow family members to take over a mortgage when they inherit residential property. That prevents lenders from demanding payment under a due-on-sale clause, which would be triggered when ownership transfers to your heirs. Heirs do not need to prove they have the ability to repay the loan before taking over the mortgage.
Repaying and Refinancing
Heirs are not required to keep the mortgage in place after you die, but the final decision lies with the executor of the will. They can refinance the loan if there’s a better one available, or they can just pay off the debt entirely. If you have significant assets in your estate at death, having your executor pay off the loan allows heirs to take the home free and clear.
Married Couples
For most married couples, the process is straightforward. If both spouses own the home and applied for the loan together, the surviving spouse generally takes over everything (ownership of the house and responsibility for the loan).
Co-Signers
If anyone co-signed for the home loan, that individual would be liable for paying off the debt—whether or not they live in the home or have an ownership interest.
Selling the Home
In some cases, heirs may not be able to take over the mortgage. Whether they can’t afford the payments or don’t want the property, selling the home is always an option.
Positive Equity
If the home is worth more than is owed on it, the difference can go to your heirs. Your executor can sell the property and use the proceeds to pay off other debts or distribute assets to heirs. Alternatively, if an individual heir takes over the mortgage and ownership of the home, they can pocket the difference.
Negative Equity
If you owe more than the home is worth—and no one wants to take over payments—your executor may be able to negotiate a short sale with your lender. If all else fails, the lender can simply foreclose, and your loved ones won’t be responsible for the debt—as long as they didn’t co-sign on the mortgage.
Reverse Mortgages
Reverse mortgages are different because you don’t make monthly payments. Home Equity Conversion Mortgages (HECMs) are the most common types of these types of loans, which must be paid off after the last borrower (or eligible spouse) dies or moves out. After that, the heirs will receive a due-and-payable notice from the lender. If they want to keep the home, they’ll have 30 days to pay off the full loan balance or 95% of the home’s appraised value—whichever is less. If they want to sell the home, then the lender will take the proceeds as repayment for the loan.
How to Prepare
Some basic estate planning will make things easier for everybody. Speak with a local attorney, describe what you hope to accomplish, and ask how best to make it happen. The sooner, the better. A simple will might do the trick, or you can use additional strategies.
Life Insurance
Life insurance may provide a quick cash injection to help your heirs pay off your home loan or keep up with monthly payments. That money can give everyone options, including a surviving spouse who might or might not want to keep the home. If a co-signer helped you get approved, you can get them off the hook.
Ownership Options
With the help of qualified professionals, evaluate whether or not it makes sense to hold your real estate in a trust or a business entity such as an LLC. Adding additional owners to the title could also be an option. Any action that keeps your home out of probate can help to reduce costs and smooth the transition for your heirs. However, those changes may have significant legal and tax consequences, so consult with a local attorney and CPA before you take any action.
Keep Liquid Cash
Especially if your family members will have a hard time making payments after your death, make funds available to them. That will help them minimize stress and paperwork, and they can sell the home for a fair price if that’s what needs to happen. In the meantime, they’ll need to pay the mortgage, maintain the property, and stay current on taxes.
Talk About It
Discuss your intentions with anyone who will be affected by your death. It’s not fun, and it’s harder for some than for others, but communication can go a long way toward preventing heartache when the inevitable happens. Find out whether loved ones want to keep the house or whether they’d prefer to move on. If you have multiple heirs, clarify who gets what—and under what conditions. For example, if one person will get the house, will the estate pay off the mortgage, or will that individual inherit the home loan along with the property?
