In addition to the sorrow of losing a loved one, inheriting a house with a mortgage can be a stressful time, especially when there are several heirs. If you want to claim full possession of the house, you’ll need to buy out the other heirs. One way to do this is by refinancing the inherited property.
Refinancing an inherited property explained
The inheritance rules can be more flexible for surviving spouses and children. Mortgage loans have what’s called a “due-on-sale” clause that requires the loan to be paid in full if it transfers to a new owner. However, lenders are prohibited by federal law from enforcing this clause if you inherit property from an immediate family member.
When inheriting a property with a mortgage, there are two possible scenarios you’ll have to plan for:
- Inheriting the estate as the lone heir: This is the most straightforward scenario. You can simply transfer the mortgage to your name and assume payments.
- Inheriting the estate with multiple heirs: You and the co-heirs will need to work with the executor of the estate and mortgage lender to decide what will happen to the property. If you want to own the property but don’t have the funds on hand to buy out each heir, you can opt for a cash-out refinance and use the proceeds from that to buy out the heirs.
Tip
It’s essential to determine the estate value for each heir early during the refinancing process so you can estimate the total buyout cost. You and the heirs will also need to pay off any outstanding balance on the mortgage before you can receive the home.
Read: What Happens to Your Mortgage When You Die?
How to refinance an inherited property to buy out heirs
You can follow these steps to refinance your loved one’s property:
- Review the estate plan: The deceased’s will should list the heirs entitled to a share of the property. The heirs and the estate executor can estimate how much each heir receives from the estate.
- Communicate with co-heirs: It’s important to discuss your mortgage transfer and refinance options with the other inheritors to avoid disputes. Determine the property value, expenses, and buyout amounts to estimate your borrowing needs.
- Transfer the mortgage deed: You’ll need to continue making mortgage payments during the transition to prevent foreclosure. However, it’s possible to add your name to the deed and assume the current payment terms. Contact the mortgage servicer for more info.
- Review due-on-sale clauses: Most mortgages have a due-on-sale clause requiring the remaining loan balance to be paid in full on transferred mortgages. The Garn-St. Germain Act of 1982 prohibits lenders from enforcing this clause when a borrower dies and a family member inherits the property.
- Calculate your refinancing terms: Prequalifying for a mortgage refinance will provide you with an estimate of your new monthly payment and payment schedule. If mortgage rates are lower than the current rate, refinancing can help you save money on interest.
- Complete the refinancing process: After finding the best lender, it’s time to apply for a refinance and secure a new rate and term. The lender will require a home appraisal to determine the value of the home (and, in turn, the available equity). Other closing costs will also apply.
- Pay each heir: If you get a cash-out refinance, you’ll receive a lump sum payment which you can use to pay the remaining heirs. As the refinanced mortgage is in your name, you’ll be responsible for making all mortgage payments going forward.
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Other options
Refinancing may not be the best option if you cannot find favorable terms or raise enough funds to buy out your co-heirs.
1. Rent or sell the property
Renting or selling the property can be the best option when your family cannot agree on a settlement amount or the court requires the estate to sell the home.
You may also have to sell the inherited property if it has a reverse mortgage as there may be insufficient equity to refinance or buy out the heirs.
Tip
If you cannot afford to refinance right now, turning the house into a rental property can help you continue to pay the mortgage and build equity. You can always decide to refinance or sell later when your circumstances improve.
2. Assume the mortgage
You might be able to assume the current mortgage payments by meeting the lender’s minimum standards. This can be the smarter option if the current loan terms are better than your refinancing options.
If you’re a co-borrower or cosigner, assuming the mortgage requires minimal effort as you are already on the mortgage and responsible for payments. The guidelines, however, can be different for conventional and government-backed mortgages.
3. Request loan modification
After adding your name to an inherited home loan, you’re considered a “successor in interest,” which essentially means you have an ownership stake in the property but you aren’t required to repay the loan. If the current loan terms are difficult to afford, you can request a loan modification.
A loan modification allows you to permanently change the terms of your mortgage. Your mortgage modification might involve:
- Extending the repayment term
- Reducing the interest rate
- Switching to a fixed interest rate
Federal guidelines don’t require the lender or servicer to determine your ability to repay the mortgage before you can take it over and modify the terms. As a result, a loan modification can be easier to qualify for than a mortgage refinance.
4. Use a home equity line of credit (HELOC)
If the remaining mortgage balance on the inherited property is small — and assuming you own a home with equity — you can use a home equity line of credit to pay off the mortgage and other heirs.
A HELOC generally has lower closing costs than a cash-out refinance (and some lenders may even waive these costs), making it a good choice if you’re limited on cash. HELOCs are also more flexible than cash-out refinances in that you can borrow any amount (up to your limit) at any time — and you’re not charged interest for any unused funds.
Downsides of a HELOC to consider
Some drawbacks to this option are that HELOCs tend to come with an adjustable interest rate and a shorter repayment period. You’ll also be responsible for two loans instead of just one.
5. Inherit a house free and clear
Depending on the estate plan instructions, you might be able to inherit the property free and clear — that is, without any debts or liens attached to the home. In this situation, the estate uses liquid assets — like investments or cash — to pay off the mortgage.
If any balance remains, you can pursue refinancing or make a lump sum payment from your savings.
6. Consider hard money loans
Hard money loans from private lenders can be easier to qualify for than traditional mortgage refinancing and often have a quicker closing process. But, unfortunately, these loans typically have short repayment terms and come with much higher interest rates.
If you need to pay the heirs fast and can’t qualify for a home equity loan or cash-out refinance, you might consider this loan. Many hard money loans can close in just a few business days.
Important
Hard money loan interest rates can range from 7% to 15%, and maybe even higher depending on the lender. While they are a viable option if you’re in a pinch, make sure to consider other, less-riskier options first.
7. Pursue foreclosure
Foreclosure might be the least desirable option. With foreclosure, you'll lose possession of the house and cannot tap the home equity.
Current laws don’t require survivors to continue making mortgage payments unless they are a co-borrower or cosigner on the mortgage.
If neither you nor another heir wants to take over the mortgage payments, the mortgage servicer can pursue foreclosure without damaging your finances.
Good to know
A court may also order foreclosure if the estate plan doesn’t detail how to pass on the property or the heirs cannot reach a distribution agreement.
Tips on refinancing inherited property
These suggestions can make the estate settlement and refinance process go more smoothly:
- Identify co-borrowers and cosigners: Co-borrowers and cosigners are automatically responsible for making payments. It can be easier to inherit the property if you already have one of these designations when the estate plan instructions are unclear about how to liquidate a property.
- Determine who pays the refinancing costs: Unfortunately, closing costs can reduce the available equity or require out-of-pocket payment. You must decide if you’ll pay all the costs or split them between the other heirs.
- Try to reduce the mortgage balance: Look for ways to reduce the mortgage principal so you won’t have to refinance as much. One option is to sell off the estate’s liquid assets.
- Compare lenders: Getting quotes from several mortgage refinance lenders can help you find favorable loan terms and also minimize your closing costs.
- Determine how to use the home equity: Calculate the percentage each heir will receive from the cash-out refinance payment in advance.
- Estimate inheritance taxes: Federal and state inheritance taxes may apply to any inheritance you receive. There can be exemptions for surviving spouses and children. A tax professional can provide additional guidance.
- Hire an estate lawyer: It can be difficult to probate an estate with outstanding debt. An estate lawyer can help you settle disputes between heirs, advise you on taxes, and navigate you through the refinancing process.
