How Does Having a Mortgage Affect the Estate Planning Process?

Most mortgages include a due-on-sale clause that gives lenders the right to full repayment of the loan upon the sale or transfer of the property. The Garn-St. Germain Act protects some transfers from triggering due-on-sale clauses, but not others. 

It is important to know whether the transfer of property will trigger these clauses when creating an estate plan.

Due-on-Sale Clauses

Due-on-sale clauses or “acceleration clauses” exist to protect banks and lenders from sudden mortgage transfers to unauthorized borrowers. During a normal property sale, the due-on-sale clause requires the seller of property to pay off the mortgage. 

In situations where the property is transferred but no money is generated, like during the creation of a trust or when the property transfers as inheritance, these clauses could effectively force the sale of the property. This happens because banks often use title transfers as opportunities to refinance loans, requiring the owner to requalify for the loan with less favorable rates than they had before. When owners fail to qualify for substitute financing, they are left with no other option but to sell the property.

The Garn-St. Germain Act

The Garn-St. Germain Depository Institutions Act of 1982 is a federal law that created exceptions to the due-on-sale clauses for some of the most common transfers. These exceptions prevent lenders from demanding immediate payment upon transfer and allow the new owner to assume the existing mortgage.

One of the most common transfers made during the estate planning process is the transfer of a mortgaged primary home into a trust. Garn-St. Germain protects this type of transfer, preventing the lender from enforcing a due-on sale clause. In contrast, this same transfer of property to a trust made with a mortgaged rental property instead of a mortgaged primary residence is not protected. This is why it is crucial to be aware of the specific protected transfers outlined in the act. 

Protected Transfers:

Transfers to a Living Trust: Property transferred to a living trust, where the mortgage holder is the beneficiary and does not change the occupancy rights of the property, will not trigger a due-on-sale clause.

Transfers to Family through lifetime transfers to a spouse or child: Transfers made during the lifetime of the original mortgage holder to a spouse or child are always protected and will not trigger a due-on-sale clause. 

Inheritance by relatives: Property inherited by a relative through a will, trust, or intestate inheritance will not trigger a due-on-sale clause. This helps heirs who may not qualify for a new loan or may not be able to get the same favorable interest rate as the original mortgage to keep the property.

Divorce or separation: When the transfer is made as a part of a divorce or separation agreement to an ex-spouse, the transfer is protected and will not trigger a due-on-sale clause.

Transfers to Joint Owners with Multiple owners on the deed: When the property is owned by two individuals and one passes leaving the property to the other, the transfer is a protected transfer and will not trigger a due-on-sale clause.

Limitations on Garn-St Germain:

Irrevocable trust transfers: Irrevocable trusts are commonly created with the intention of gaining tax benefits, which requires the beneficiary to be distinct from the grantor. The change of beneficiary creates an unprotected transfer that can trigger a due-on-sale clause.

Lifetime Transfers to Relatives - Child to parent: Lifetime transfers that travel upwards, such as child to parent, are not protected. The act only protects downward lifetime transfers, limiting the protection to transfers from spouse to spouse or parent to child. 

Qualifying Mortgages-Reverse mortgages: Reverse mortgages are designed to give owners payments in exchange for the equity in their homes. These mortgages are not protected by Garn-St. Germain act, and any transfers can require refinancing or full repayment based on the terms of the reverse mortgage.

Qualifying Property Types -Rental properties: These properties are not assumed to be protected, due to the limiting language in subsequent federal laws that has been read to limit the application of the Garn-St. Germain act to loans on borrower-occupied homes.

Commercial properties: These properties are never protected by Garn-St. Germain exceptions, and any transfer can trigger a due on sale clause.

Limited Liability Company (LLC) transfers: Transfers to LLCs: The transfer to a limited liability company is not protected and can trigger a due-on-sale clause.

Conclusion

A due-on-sale clause is an essential function of a mortgage, but it can create complications in estate planning that need to be properly planned for. Your attorney may take special measures to ensure the transfer is protected and will not trigger the due-on-sale clause. 

In some cases, unprotected transfers may be deemed necessary, and there are steps to take to ensure the assignment is protected by receiving approval from the lender before any transfers are made. 

Contact us if you have any questions or would like to speak about you can manage your real property in your estate plan.