Can the Bank Make Me Refinance?

Can the Bank Make Me Refinance?

Download Printable Version

Heirs and beneficiaries often call the firm asking whether they need to refinance when they inherit property. Many worry they could not qualify for a loan on the property they inherited. Although the law regarding forced refinancing is clear and settled, most folks are unaware of their rights.

Mortgages 101

Most debt is cancelled on the death of the debtor. The word ‘mortgage’ comes from French and means ‘death promise.’ Legal writing uses many “-ors “and “-ees” and this can be confusing to the lay reader. What differentiates the two is that the -or initiates the promise- an employer hires an employee and a payor pays a payee, grantors give and grantees receive. In the context of home lending, a mortgagor (buyer) promises to pay a mortgagee (bank) back.

When first used in merry old England, the idea was that the lender would get paid whether the borrower lived or died. In modern usage, a mortgage is a type of secured debt. The difference between secured debt (e.g. a mortgage) and unsecured debt (e.g. a credit card) is that in a secured debt the borrower both promises to pay the creditor the amount borrowed and secures that promise with other property. If the promise is not paid on time, the lender can force the sale of the property and pay itself back with the proceeds. If funds remain after the sale, then they go back to the borrower. If the funds are not sufficient to pay the balance, the lender (mortgagee) can get a judgment from a court to collect the balance, called a ‘deficiency judgment.’

Due-On-Sale

We just explored how a secured creditor can collect upon nonpayment of a loan if it is not paid on time. Many mortgages contain clauses that make the outstanding principal balance due immediately upon the transfer of a property if that transfer happens without the prior written consent of the lender. These ‘due-on-sale‘ clauses are inserted to protect the lender from holding a debt on property the mortgagor no longer owns.

Garn-St Germain

To codify the enforceability of due-on-sale clauses, congress passed the Garn-St Germain Depository Institutions Regulation Act (Garn-St Germain) in 1982. This law provided exclusions to the enforceability of due-on-sale clauses, some of which have great relevance to estate planning (listed below in full):

Garn-St Germain (12 US Code Sec 1701-j-3(d)

(d) Exemption of specified transfers or dispositions: With respect to a real property loan secured by a lien on residential real property containing less than five dwelling units, including a lien on the stock allocated to a dwelling unit in a cooperative housing corporation, or on a residential manufactured home, a lender may not exercise its option pursuant to a due-on-sale clause upon—

(1) the creation of a lien or other encumbrance subordinate to the lender’s security instrument which does not relate to a transfer of rights of occupancy in the property;

(2) the creation of a purchase money security interest for household appliances;

(3) a transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety;

(4) the granting of a leasehold interest of three years or less not containing an option to purchase;

(5) a transfer to a relative resulting from the death of a borrower;

(6) a transfer where the spouse or children of the borrower become an owner of the property;

(7) a transfer resulting from a decree of a dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement, by which the spouse of the borrower becomes an owner of the property;

(8) a transfer into an inter vivos [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; or

(9) any other transfer or disposition described in regulations prescribed by the Federal Home Loan Bank Board.

Let’s look at a few of these exceptions in depth (numbers used are from statute, above):

  1. the creation of a lien or other encumbrance subordinate to the lender’s security instrument which does not relate to a transfer of rights of occupancy in the property;

This means your first mortgage cannot call your loan if you get a second mortgage on a property.

(3) a transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety;

This means you do not need to refinance if you are the surviving joint tenant - that is to say you were a joint owner and the other joint owner dies.

(5) a transfer to a relative resulting from the death of a borrower;

If you inherit mortgaged property from a relative, you do not need to refinance the mortgage. You do need to keep up the payments, of course.

(6) a transfer where the spouse or children of the borrower become an owner of the property;

If a house is transferred in life to a grantor’s spouse or children, the spouse/children need not refinance-they can keep paying the original loan.

(7) a transfer resulting from a decree of a dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement, by which the spouse of the borrower becomes an owner of the property;

A divorcee taking title as part of a divorce does not need to refinance.

(8) a transfer into an inter vivos 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;

This one is critical to the estate planning side of the house. There is no need to refinance a property that goes into a living trust for estate planning purposes.

Warning about LLCs

Note that there is no exception for transferring an encumbered property into a LLC. JGB has always recommended that an owner should not transfer a mortgaged property into a LLC without the prior written consent of the lender.

Conclusion

Many people don’t know their rights about due-on-sale clauses and some banks don’t either. If you inherit property from your parents you do not need to refinance the mortgage. If one of these exceptions applies to you and you receive correspondence telling you that you should refinance, see your attorney to protect your rights.

This will be an increasingly important issue in the upcoming years, when the unusually low rates we now enjoy are replaced by normal interest rates over the next few years. Lenders will have a strong incentive to make folks refinance their 3-4% loan rate from the early 2000s so the lender can instead benefit from a higher interest rate. Heirs will need to be aware of and assert their rights.

Notice to our clients and friends-

Our E-mail filters have been overactive lately. If you send us an email and do not hear back in one business day, please call the office to follow up. The filters blocked my own email of the draft of this email from my iPad to my desktop.

Categories:

Contact Us Today

Work with Attorneys Devoted to Your Best Interests
    • Please enter your name.
    • Please enter your name.
    • Please enter your email address.
      This isn't a valid email address.
    • Please make a selection.
    • Please enter a message.