What happens to your mortgage when you die?
If your parents' home has been paid off, your only obligation if you inherit the property is to pay the property taxes and homeowners insurance until you sell it. But what if your parents left you a mortgage balance along with the property?
While the mortgage is technically not yours unless you are a cosigner, if you don't make the mortgage payments or sell the house, your parent's lender can start foreclosure proceedings, says Jeff Cutter, a CPA and owner of Cutter Financial Group in Falmouth, Mass.
"The conversation about what will happen to the family home is an emotional one that lots of elderly parents don't want to initiate," says Guy Penn, principal and founder of G. M. Penn Wealth Management in O'Fallon, Mo. The time to discuss how to handle your parent's estate is before they pass away, no matter how difficult that conversation might be, says Penn.
Mike Piershale, president of Piershale Financial Group in Crystal Lake, Ill., says the most important part of estate planning is to avoid probate so the inherited property can transition smoothly and inexpensively to the heirs.
In general, probate is the legal process by which your estate is administered and processed after you pass away. Specifically, it's the legal process of validating the will.
"It can take nine months to a year before [the] heirs own the house if it goes through probate," says Piershale. "Probate taxes can be 6 percent or more of the home's value."
4 property dispersal options
Here are four options to discuss with a financial advisor about how to handle an aging parent's estate before they pass away:
No. 1: Put the property in a trust. Piershale says the best solution for most homeowners is to put the home in a land trust or a revocable trust.
"If your only asset is your house, then a simple land trust will be enough," he says. "A land trust puts the property title into the name of the trust rather than your name. You establish beneficiaries and then when you pass away the property goes directly to your beneficiaries without going through probate."
Even though the property has been put in a trust, the parents still have complete ownership and can sell the property at any time, says Penn.
"A trust is transparent and establishes an orderly process for transferring property which can also prevent the heirs from arguing," says Penn.
Cutter says some homeowners concerned about estate taxes for their heirs may want to establish a "Qualified Personal Residence Trust," which essentially gives your property to your kids now but allows you to live in it for the period of the trust.
No. 2: Sell the home to the kids while living. Cutter says parents can help their kids by selling them the house and then providing a private mortgage paid by the kids to their parents. The parents can benefit from the income from the mortgage payments. "The kids can improve their credit with a good payment history and the parents can gift the down payment money up to the maximum gift tax exclusion of $14,000 per person," he says. "So if a married couple is giving money to a married couple, they can give as much as $56,000 tax-free."
The downside of this, Cutter points out, is that the parents could be kicked out of their home if their kids decide they want to move in or sell it.
No. 3: Deed the home to the kids while living. Parents can also deed their home to their kids prior to their death in order to avoid probate, but Piershale warns that this can be dangerous. "If the kid gets into a car wreck and someone sues them, then your property is subject to lawsuits and liability," he says. "Another obvious issue is the danger of elder abuse because the parents no longer have control over their home."
Signing over the deed to the property won't impact the mortgage, which stays in the parents' name, says Penn.
No. 4: Will the property. While a will is better than no document at all because it establishes your beneficiaries, says Piershale, a basic will won't keep your property from going through probate.
"Even though the court follows the direction of the will, probate takes time and you'll have to pay probate taxes," says Piershale.
If you're underwater on your home or have very little equity, your heirs can decide not to accept their inheritance. In that case, the bank would take the property and sell it to pay off the remaining mortgage balance.
While talking about what to do with the family home usually isn’t the most pleasant conversation, it’s important to discuss the financial implications of property disbursement with your parents before they pass away.
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Michele Lerner, author of "HOMEBUYING: Tough Times, First Time, Any Time", has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including The Washington Post, The Motley Fool, Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT's REIT magazine and numerous Realtor associations.