When an individual dies, an estate is created. The estate includes his assets as well as liabilities, including debts. When a secured debt such as a home mortgage is present, the lender has the legal authority to seize collateral if the debt remains unpaid. This means a mortgage survives the death of its holder and may result in foreclosure on the property.
In most cases, a bank has the legal right to demand the full balance of a mortgage when the mortgagee dies unless the decedent's heirs pay off the balance or assume the loan.
Due on Sale Clause
The death of an individual normally results in secured debts becoming payable in full. Many mortgage contracts also include a "due-on-sale" clause that allows the lender to demand full repayment in case a borrower sells or transfers the property. If a borrower dies, however, the federal Garn-St. Germain Act bars lenders from "accelerating" mortgage loans. This means that as long as somebody continues paying as required on the mortgage, the lender can't enforce a due-on-sale clause.
Payoff vs. Assumption
Mortgages are not voided by the death of a borrower. Instead, they "follow the property." Although ownership changes, the loan remains secured by the land and buildings. The heirs who inherit the property may need (or choose) to pay off the mortgage; this is made easier when there is sufficient equity built up in the home to cover the balance on the mortgage.
The lender may also allow heirs to assume the mortgage at the same interest rate and repayment schedule, or allow the loan to be refinanced, which would change the repayment terms. In some cases, the heirs will have to pay off the old loan, then qualify for a new mortgage.
Sale or Foreclosure
If there are insufficient assets to keep up the mortgage, the lender may force a sale by the heirs. The proceeds of the sale would first go to satisfy the outstanding balance on the mortgage, while the remaining proceeds would be payable to the heirs. Even if it's sold, a house with insufficient equity to satisfy the mortgage balance would still be subject to a foreclosure. The new owners would lose the house to the lender unless they're able to pay off, assume or refinance the old loan balance.
Estate Payoff and Guaranteed Loans
A will may also convey a house to an heir while simultaneously paying off the mortgage debt from the estate. The loan payoff must happen before the heir can take ownership of the house. In the case of an FHA- or VA-backed loan, the guarantee of payment to the lender in the case of a borrower default does not apply – the estate and the heirs to the property are still responsible for paying the mortgage.
Life Insurance Vs. Mortgage Protection Insurance
Many lenders and insurance companies offer "mortgage protection insurance" (MPI) that will separately guarantee payment in full in case the borrower dies. The payment from this insurance policy goes directly to the lender instead of your heirs. A downside is an MPI policy decreases in value each year, because it only covers the unpaid balance of a mortgage.
Another insurance option to pay a mortgage upon the death of the borrower is a life insurance policy. Two primary differences between a life insurance policy and an MPI policy are that the policy's value does not decrease over time, and the payments are made directly to the beneficiaries ... not to the mortgage lender.
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