Who Pays the Mortgage on a Home in a Trust?

Placing your home in a trust is a common estate planning strategy that helps avoid probate and provides clear instructions for the property after your death. However, when there’s an existing mortgage on a home in a trust, many homeowners wonder who becomes responsible for those payments. Understanding how mortgages work with trusts is essential to avoid potential financial and legal complications. This article explains the responsibilities, protections, and considerations when transferring a mortgaged home into a trust.

Revocable Trusts and How They Handle a Mortgage on a Home in a Trust

A revocable trust stands out as the most effective and widely utilized type of trust in estate planning. This type of trust allows you to maintain control of your assets during your lifetime. It also provides instructions for their management after your death.

When you transfer a mortgaged home into a revocable living trust, the responsibility for mortgage payments typically remains with you as the grantor (the person who created the trust). This is because:

• Usually, you retain beneficial ownership of the property.
• The trust is simply a legal vehicle that holds the title.
• Your financial obligations to the lender remain unchanged.

It’s important to understand that transferring your home to a living trust does not eliminate or change your mortgage obligation. You remain bound by the promissory note you signed when you took out the mortgage, no matter how the property is titled. If you stop making payments, the lender may seize the property through foreclosure, even if you’ve placed it in a trust.

Most people who create a revocable living trust name themselves as the trustee, which means they maintain direct control over all trust assets, including making mortgage payments. Even if you name someone else as trustee, the responsibility for mortgage payments typically remains with the grantor, who is also usually the primary beneficiary of the trust.

Managing a Mortgage on a Home in a Trust Through an Irrevocable Trust

Unlike a revocable living trust, an irrevocable trust is fundamentally rigid because once the grantor establishes it, they cannot easily alter or terminate it. When you place a mortgaged home in an irrevocable trust, the payment responsibility situation becomes more complex.

In an irrevocable trust arrangement:

• The trustee becomes legally responsible for managing the property.
• The trust itself should have sufficient funds or income to cover mortgage payments.
• The original borrower may still be personally liable for the debt.
• The trustee must make timely payments to avoid foreclosure.

Suppose the irrevocable trust lacks adequate resources to make mortgage payments. The grantor or another designated party may need to contribute funds to the trust specifically for this purpose. The trust documents should clearly outline this arrangement to avoid confusion or missed payments.

Some irrevocable trusts generate income through investments or rental properties. And the trustee can use that income to cover mortgage obligations. The trustee is responsible for managing these income streams. They must ensure that mortgage payments receive appropriate priority among the trust’s financial obligations.

Because of these complexities, it’s generally more challenging to place a mortgaged property in an irrevocable trust compared to a revocable trust. People typically create irrevocable trusts to achieve specific tax planning or asset protection goals that outweigh these complications.

Due-on-Sale Clauses When Transferring a Mortgaged Home into a Trust

Most mortgage agreements include a ‘due-on-sale’ clause. This allows the lender to demand full repayment of the loan if the property is transferred to someone else. So transferring a mortgaged home into a trust can trigger this clause.

Fortunately, federal law provides important protection for homeowners. The Garn-St. Germain Depository Institutions Act of 1982 specifically prevents lenders from enforcing due-on-sale clauses in certain situations, including:

• Transfers to a living trust where the borrower is a beneficiary
• Transfers resulting from death where a relative inherits the property
• Transfers between spouses or during a divorce
• Transfers that add a spouse as co-owner

This federal protection is particularly important for homeowners placing their primary residence in a revocable living trust. As long as you remain a beneficiary of the trust and continue to occupy the home, the lender cannot use the transfer as grounds to accelerate the loan.

However, it’s still important to check with your specific lender before transferring a mortgaged property into any trust. Some lenders may have additional requirements or paperwork to complete, even though they cannot legally enforce the due-on-sale clause in these protected situations.

For investment properties or second homes, lenders may offer fewer protections, so property owners should exercise additional caution when transferring non-primary residences into a trust. If you have a mortgage on a home you want to transfer to a trust, it is important to learn more about the Garn-St. Germain Act and its specific provisions regarding mortgage transfers.

Foreclosure Risk and Mortgage Obligations for Homes in a Trust

Placing a home in a trust does not provide any special protection against foreclosure if the homeowner fails to make mortgage payments. The lender’s security interest in the property remains intact regardless of how the property is titled. Here are some key points about foreclosure risk for homes in trusts:

• The lender can foreclose on a trust-owned property just as they would on any other mortgaged property.
• The foreclosure process follows the same legal procedures regardless of trust ownership.
• The trustee will receive foreclosure notices and must respond appropriately.
• Trust beneficiaries may have limited ability to intervene in foreclosure proceedings.

For revocable living trusts, the grantor (who is typically also the trustee) remains directly involved in any foreclosure proceedings. For irrevocable trusts, the named trustee is responsible for addressing foreclosure notices and taking appropriate action to either cure the default or manage the foreclosure process.

Some homeowners mistakenly believe that placing their home in a trust will shield it from creditors or prevent foreclosure. This is not the case. While certain types of irrevocable trusts may offer some asset protection benefits, they do not eliminate the lender’s right to foreclose if the borrower fails to make payments as agreed.

Practical Considerations

Beyond the legal aspects of who pays the mortgage, there are several practical considerations when placing a mortgaged home in a trust.

Refinancing Challenges: Refinancing a home held in a trust can present additional steps. Some lenders require the property to be temporarily transferred out of the trust during the refinancing process. It is then transferred back into the trust afterward. This involves additional paperwork and potentially some extra costs.

Insurance Considerations: When a home is transferred to a trust, it is essential to notify your homeowner’s insurance company to ensure proper coverage. The policy might need updating to include the trust as an additional insured while still covering the occupants.

Property Tax Implications and Homestead Exemptions: Transferring your home to a revocable living trust may not affect property tax assessments, homestead exemptions, or property tax relief programs. However, certain jurisdictions have specific rules for preserving these benefits when a property is held in a revocable trust, particularly with regard to homestead exemptions that are only available to spouses jointly owning property. So it is important to check with your local tax assessor’s office for guidance, the state, if they offer an exemption or rebate program, or consult with an attorney about legal implications.

Transferring a home to an irrevocable trust will likely impact property tax relief programs and homestead exemptions. Once again, it is essential to consult with local/state authorities or an attorney knowledgeable about these topics.

Record-Keeping: Maintaining clear records of mortgage payments made by or on behalf of the trust is important, especially for irrevocable trusts. These records help demonstrate that the trust is fulfilling its obligations and can be important for accounting and tax purposes.

Conclusion

When a home with a mortgage is placed in a trust, the responsibility for making mortgage payments mainly depends on the type of trust established. For revocable living trusts, the grantor usually remains responsible for payments. For irrevocable trusts, the trustee must ensure that payments are made from trust assets or other specified sources.

Federal law protects borrowers from lenders calling loans due when a home is transferred to a trust, provided the borrower remains a beneficiary. However, these protections don’t eliminate the obligation to continue making mortgage payments.

Placing a mortgaged home in a trust can be a valuable estate planning tool when done correctly. It allows for the orderly management and transfer of the property while maintaining the existing mortgage arrangement. However, it’s important to understand that the mortgage obligation continues regardless of how the property is titled.

For personalized guidance on your specific situation, consider consulting with an estate planning attorney. An attorney can help structure your trust to align with your mortgage obligations and overall estate planning goals. With proper planning, you can successfully balance mortgage responsibilities with the benefits of trust ownership. For more inquiries related to New Jersey and New York estate planning, please feel free to contact The Chamberlain Law Firm by clicking here or calling us at (201) 273-9763.

This article is for general legal information only. It is not legal advice to rely on for your specific fact pattern. No opinion expressed above can be used to avoid tax penalties that may be imposed otherwise on the reader, nor to promote or market to any other person any transaction or matter addressed herein. Advice to rely on can be gotten only after a thorough discussion and investigation of the facts of your situation with counsel licensed in your state. No attorney-client relationship has been established by this communication.