If you inherit real estate, the existing mortgage doesn’t need to be immediately paid off. You can take possession of the property, assume the mortgage (or refinance it) and continue making payments.
It’s been estimated about 62% of American homeowners have a mortgage. For a deceased person, their house is often their largest asset. The heirs want their inheritance, and the bank wants to get paid. So what happens to the mortgage taken out by the deceased person?
A homeowner dies. This favorite aunt or uncle left you their house in their will. Inheriting a house is a great thing! The house has an existing mortgage. You can take possession of the house and assume the mortgage. Once the property is yours, you can live in it, use it as a rental property or sell it. You can refinance it. Once you sell it, the mortgage must be paid off.
What happens to the mortgage if you inherit a house with a mortgage?
Who’s responsible for a mortgage after the borrower dies?
This question can have multiple answers depending on your (and your family’s) circumstances and the specifics of the mortgage. Here are four scenarios to consider:
The cosigner on the mortgage
You’ve heard the expression “cosigning a loan.” That’s when someone else accepts responsibility if the other party doesn’t pay like they are supposed to pay. The mortgage might be in two names, especially if the house is held in joint name. In that case, the surviving cosigner is responsible.
The estate of the deceased
When people make wills, they usually appoint an executor. Their responsibility is to fill out the necessary paperwork and settle the estate. If there are many heirs and the house is simply considered another asset to be turned into cash, the executor may continue making mortgage payments as they put the house up for sale.
The heir who inherits
We are getting ahead of ourselves here, but let’s assume only one parent was alive, they died, and they had only one child, who was the heir. The child has been willed the house. They want to live in it or at least hold it for a while. They would go through a process with the bank, but they would basically assume the mortgage.
Suppose there was no will, no family, and no executor. One day, the bank stopped receiving monthly mortgage payments. They would send letters and make phone calls. Still, nothing happens. After a few months, the bank would consider the mortgage in default and foreclose on the property. This allows the bank to sell the property to recoup the outstanding mortgage amount.
Taking over the mortgage on an inherited house
The bank (or whoever owns the mortgage now) wants to get paid. That’s all it cares about. When they wrote the mortgage, they were prepared to wait, collecting interest and principal on a monthly basis along the way. The point is the bank has usually no issues with someone else assuming the loan. The point of contact is likely the mortgage service company, the ones collecting the payments, calculating escrow, and issuing tax documentation.
You will need to prove a few things that will seem pretty obvious. The owner of the house, the person whose name is on the mortgage, is actually dead. A death certificate should be sufficient. Proof they owned the house and the mortgage is in the deceased’s name is also important. You will need proof the house has been left to you as the beneficiary.
The Consumer Financial Protection Bureau has a rule allowing banks to add the borrower’s heir’s name to the mortgage without going through the Ability to Repay Rule.
Suppose you’ve inherited the house but can’t afford the mortgage payments? You would talk with the lender about a loan modification.
Get information on the mortgage
This should be pretty straightforward. Ideally the deceased maintained an “Important Documents” file at home that included the mortgage. If not, a bill comes in the mail every month from the mortgage company. If the payments are made as a direct debit to their checking account, they would still receive a tax reporting statement at the end of the year. Their accountant should have this information.
What are your options?
So you have an inherited house! What next? The first thing to do is consider your options. You might think taking possession of the house is the obvious choice. What if the real estate market is in bad shape and the house is “underwater,” meaning the bank is owed more money than the property is worth. Perhaps taking possession is not such a great idea. The house might stay in the estate, and the bank would foreclose. This has its own set of issues because if the bank sells the house for less than the outstanding loan the bank can — in some states — come after the deceased’s estate for the balance. The term for the excess amount is a deficiency judgment.
What to do with an inherited house
Let’s assume that’s not the case. The mortgage question has been addressed. The house is now in your name. You own the house.
Welcome to your new home. It’s in a better neighborhood with good schools. Maybe the property is your vacation home. Enjoy it. Maintain it. Pay the bills.
Suppose it’s on the same city block. Maybe it’s in an entirely different state. You know the house has value. You have faith in the real estate market. Contact a property management company or rent the house out on your own. Now you have an income-producing asset, along with the responsibilities of being a landlord.
The house is in a different state. Maybe the house is in bad condition. Perhaps you have a better use for the cash. The house is an asset that you own. You can always choose to sell the house. Find yourself a good real estate agent familiar with the local market. If you go in this direction and the house still has a mortgage, you will be expected to pay off the mortgage when the property is sold.
Give it away
You don’t need another house. The mortgage has been paid off. Your grown child just got married. Perhaps you give them the house as a gift. This can have tax complications, specifically related to the gift tax. Here’s another scenario. You are wealthy. You support various charities. They need money. You have the house, a hard asset. You gift the house to charity and take the tax deduction.
Tax implications when selling an inherited house
Suppose you decide you would rather have the cash, not own more real estate. You could choose to sell your inherited property. What kind of tax bill can you expect? There are special tax rules when you sell a house you inherit.
When you inherit an asset such as a house or negotiable securities like stocks and bonds, the cost basis is “stepped up” to the value at the time of the decedent’s death. Put another way; your relative might have owned the house for decades. It appreciated in value significantly. If they sold the house at fair market value during their lifetime, they would owe taxes on the realized capital gains, subject to certain threshold exclusions if it’s their primary residence.
The rules change when the house is inherited by an heir because the cost of the house is considered the value of the house on the day the previous owner died. If you sold the house immediately upon inheriting, there would be little or no capital gain, therefore little or no tax. If you kept the house as an investment and it wasn’t your primary residence, then sold it a few years later, your capital gains tax liability would be based on the difference in value between the time the previous owner died and the time you sold it.
Why is the government ready to let someone off the hook for capital gains taxes? Because the house was counted into the value of the deceased person’s estate, which is subject to estate tax. The good news is there are thresholds for exclusion, so most people don’t have to pay estate taxes. However, many states have estate tax or inheritance taxes to consider.
Who qualifies for the home sale tax exclusion?
Tax law provides homeowners with a tax exclusion of up to $250,000 of any gain from the sale of a home. Married homeowners filing jointly get up to $500,000. However, to qualify for the exclusion, you have to use the property as your main home for two years out of the prior five years before the sale.
If you inherit a home, you probably won’t qualify for this exclusion. In most cases, you would have to move into the home and live there for two years to qualify. However, as mentioned above, you might not need the tax exclusion because the basis of the property often gets a step-up when you inherit a home.
In general, it’s a good idea to consult an accountant, lawyer, or another tax advisor to get professional advice when you inherit a property. The government wants people to pay taxes, but there are ways to minimize your tax bill.
How to finance an inherited house
Now you own this house. What are the financial considerations? Put another way, can you get money out or reduce your expenses?
Mortgage take over
You assumed the obligation for an outstanding mortgage when you inherit a house. This is the simplest and smoothest answer to financing the house because the financing is already in place. You assumed responsibility for the mortgage.
Purchase or refinance mortgage
You now own the house and the mortgage that came along with it. Interest rates are substantially lower than when the now-deceased owner originally purchased the house and got a mortgage. You can refinance at a lower interest rate. That’s what you do.
You’ve inherited this house and the mortgage is very small because the deceased was making monthly payments for decades. Put another way; there’s plenty of equity in the house. Another possibility is the house has appreciated substantially since it was originally purchased. You refinance the house with a larger mortgage, enabling you to pay off the remaining, smaller mortgage and take cash out.
Investment property loan
This is a less likely option, but let’s assume you are intending to rent out the property. Banks like to lend to people who will be living in the property. Why? Because people usually maintain their own homes. Banks will lend for income-producing property, often at a higher interest rate and a higher down payment. So the mortgage rate you inherited might be pretty attractive. This would only make sense if there was a big difference between the rate on the mortgage you already have and the rate on an investment property loan.
What about a reverse mortgage?
You hear them advertised on TV all the time. It’s called a reverse mortgage because it works the opposite of how a conventional mortgage works. A conventional mortgage is gradually paid off over time through monthly payments consisting of interest and principal. The loan is reduced until it has been fully paid off.
A reverse mortgage is a loan, secured by the property like a mortgage, but it gives the homeowner a lump sum, monthly income, or access to money if they need it. Since they don’t need to make interest payments, the size of the loan grows over time. The lack of loan payments makes the loan balance grow.
Upon the death of the homeowner, the reverse mortgage must be paid off. Unlike a conventional mortgage, it can’t be assumed by the heir who is inheriting the house. Hopefully the estate has liquid assets that could be sold to raise cash and pay off the reverse mortgage.
Frequently Asked Questions
Do I have to pay the mortgage on the inherited house?
You have options available. For example, you can assume the mortgage and continue making payments. Or you can pay off the outstanding balance on the mortgage. You can also sell the house. However, if you inherit the house and don’t make mortgage payments, the bank can foreclose.
Can you keep a mortgage in a dead person’s name?
In theory, a property can remain within the deceased person’s estate until the estate is settled. There might be difficulty in locating heirs or maybe the IRS has not yet accepted the estate’s tax return. The executor, acting as a fiduciary to preserve the assets of the deceased, would be continuing to make timely mortgage payments.
How do you assume a mortgage after death?
It’s a process. Start by notifying the mortgage service company. Among other things, they will need proof the borrower has died and proof you are the rightful heir.
Can a beneficiary take over a mortgage?
Yes. The government considers houses as an asset many people want to keep within their families or go to designated heirs. The Consumer Financial Protection Bureau has a rule that makes taking over a mortgage by the beneficiary easier.
What happens if property taxes are owed?
This is a debt that not only is a lien on the property but may be accruing penalties and interest. This should be paid off as quickly as possible.
- Heirs can inherit real estate and have the mortgage transition to them.
- The mortgage service provider or lender needs to be notified, so the mortgage can be transferred.
- If the real estate is simply considered another asset and isn’t designated for a specific beneficiary, the mortgage is paid off when the property is sold within the estate.
- The lender expects mortgage payments to be paid; otherwise, the property can go into foreclosure.
- Bring in the professionals, like tax attorneys or estate attorneys, when settling an estate and distributing property.
Bryce Sanders is president of Perceptive Business Solutions Inc. He provides HNW client acquisition training for the financial services industry. His book, “Captivating the Wealthy Investor” is available on Amazon. Bryce spent twenty years with a major financial services firm as a successful financial advisor. He has been published in 40+ metro market editions of American City Business Journals, Accountingweb, NAIFA’s Advisor Today, The Register, LifeHealthPro, Round the Table, the Financial Times site Financial Advisor IQ and Horsesmouth.com.