What happens to your mortgage if you should pass away before it's paid off? While it's not a pleasant thing to contemplate, it is something you should plan for if you want the property or its equity to pass to your heirs trouble-free.
The good news is that the answer is: not much. Your spouse or other relatives can inherit the property and simply keep on making the payments on your loan. Legally, they don't even have to take your name off the loan and put it in their own.
The bad news is: the lender may foreclose if payments are interrupted for 90 days or more. That can easily happen in the wake of a death, particularly if the deceased did not leave a will or other guidance for handling their affairs. As a result, the home could be lost to your heirs or they might be forced into a quick sale on unfavorable terms.
That's the short version. But as usual, the devil is in the details. Here are some of the key things to be aware of.
Keeping up the payments
The first thing, of course, is that someone has to keep up your mortgage payments when you die. Usually, this will be the executor of your estate. However, if you don't leave a will and therefore have no executor, your relatives may not be able to access funds from your estate to make the mortgage payments until the probate process is completed - which may take close to a year, even longer. If they can't make the payments on their own, they could lose the property.
In many cases, the heirs simply choose to sell the property after the owner's demise. Or, they may simply use the proceeds from life insurance or the rest of the estate to pay off the mortgage entirely. In either case, however, the mortgage payments must continue to be made under the estate is settled or the insurance payment received - which is why it's good to have a will and an executor.
Another possibility is to place your home and other assets into a living trust with your heirs as the beneficiaries. That allows you to continue to enjoy the exclusive use of them while you're alive but means they pass immediately to your heirs upon your death, with no need for probate.
Taking over the loan
If your heir is your spouse and both of you are listed as co-borrowers on the loan, there's nothing that needs to be done as far as the mortgage is concerned should you pass away. He or she simply becomes the sole borrower by default.
There is a provision called "due on sale" in most mortgages that allows the lender to demand repayment in full if the home changes hands. This is the provision that is triggered when a home is sold. Lenders sometimes seek to use it to demand full payment of the loan following the death of the borrower.
However, the due-on-sale clause cannot be enforced when the home passes to the spouse or another relative, a protection established by Congress under the 1982 Garn-St. Germain Act. However, that doesn't always prevent lenders from seeking to pressure heirs to either pay off the mortgage or refinance the loan in their own names - the latter is more likely if current mortgage rates are higher than those on the loan.
More recently, the Consumer Financial Protection Bureau (CFPB) has established additional protections for heirs, including requirements that lenders communicate the status of the mortgage (current, past due, in foreclosure, etc.) to the heirs upon being notified of the borrower's death, as well as notifying them of their eligibility to continue paying the loan or to assume the mortgage.
Reasons for assuming the mortgage
While a surviving spouse or other relative who inherits the property doesn't have to have the mortgage put in their name, even if they plan to live in the home, there are times when they may wish to do so. Having the loan in their own names allows them to take the mortgage interest deduction, for starters. It may simplify matters if they later seek a home equity loan on the property and could be useful in enhancing their own credit profile.
If the heirs are unable to assume the mortgage, the loan will likely have to be refinanced if they wish to place it under their own names.
About reverse mortgages
Another possible situation is if you have a reverse mortgage on the home at the time of your death. It may be that you were receiving a stipend from the loan or that you used it to borrow a certain amount of money once upon a time. Either way, the loan becomes due when the borrower dies or otherwise no longer occupies the home.
In many cases, the home is simply sold and the proceeds from the sale are used to pay off the reverse mortgage, with anything left over going to the heirs. However, the heirs may also choose to pay off the balance on the reverse mortgage themselves if they wish to keep the property. If they can't afford to do that on their own or using other proceeds from the estate or insurance, they might choose to take out their own mortgage on the property to pay off the reverse mortgage and maintain possession of the home.