Planning with Mortgaged Property
There are special considerations when clients have a mortgage or anticipates the need for a future mortgage. When dealing with residential mortgages, lenders strongly prefer an ordinary situation where payment is assured by the original borrower(s) and collection against the collateral (the house) is direct.
Most conventional loans today contain a “due-on-sale clause” which allows the lender to demand full repayment of a loan if the borrower sells or transfers title to the house. It is possible to have an “assumable” mortgage where a subsequent owner could take over the mortgage payments after going through a credit check and the lenders specific assumption process. FHA, VA, and USDA mortgages typically do not have due-on-sale clauses.
A due-on-sale clause can be triggered any time the ownership of a property changes, with some exceptions. Federal law (the 1982 Garn-St. Germain Act) provides some exceptions – that is protections – to when the lender may enforce a due on sale clause, for example:
- Divorce or legal separation, where property was jointly owned and becomes owned by one of the spouses;
- Transfer upon death of the borrower to a relative;
- Transfer during life to a Living Trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property . . . .” (12 U.S.C. § 1701j-3(d)(8).) This living trust can be either Revocable or Irrevocable, including an irrevocable asset protection trust.
It is important to remember that the mortgage will remain a lien against the property until it is paid off and properly discharged in the records of the County Clerk. Also, the original buyer remains personally liable for the debt until released by the lender. This is not a way for a borrower to avoid paying their debt.
Also, keep in mind there are very few lenders willing make a mortgage with an irrevocable trust. If you want to keep your future mortgage options open, an asset protection trust probably is not for you — or at least not until after the mortgage is in place.
Although, the lender is legally entitled to invoke a due-on-sale clause, there are times the lender may elect not to. For example, in a weak housing market or if the home has declined significantly in value. The lender may allow a new owner to make payments on the old mortgage rather than risk the possibility of a default and loss of a portion of what is owed. Where a lender accepts payments like this, without an approved assumption, the lender is not giving up its right to foreclose at a later date. Because this is perilous to the new owner who has been making payments, it is not recommended.
While there are special considerations to planning when a mortgage is or may be involved, it is important to get all the facts so you can make a well-informed decision.