Can You Put a House With a Mortgage in a Trust?

Holding real estate assets in a trust can provide significant benefits for estate planning and asset protection purposes. But what if you still have a mortgage on your home is it possible to transfer that mortgaged property into a trust? The short answer is yes, you can put a house with a mortgage into either a revocable living trust or an irrevocable trust. However, there are some key considerations to keep in mind during the process.

In this comprehensive guide, we’ll explore how to put a mortgaged house into a trust, the pros and cons of using revocable vs. irrevocable trusts, important legal and tax implications, and tips for ensuring a smooth transfer with guidance from professionals.

What is a Trust and Why Use One for Your Home?

A trust is a fiduciary arrangement where a third party (the trustee) holds and manages assets on behalf of a beneficiary or beneficiaries. Trusts can be established during your lifetime (living trusts) or upon your death (testamentary trusts).

Two main types of trusts are:

1. Revocable Living Trust: You maintain control of assets in the trust during your lifetime and can make changes or revoke it. This allows you to avoid probate.
2. Irrevocable Trust: Once established, you no longer own the trust assets, which are permanently removed from your taxable estate. This provides asset protection but you give up control.

Using a trust for your home can help avoid the costly and lengthy probate process upon your death. It can minimize estate taxes, protect assets from creditors and lawsuits, provide for beneficiaries according to your wishes, and smooth the inheritance process.

However, putting a mortgaged property into a trust has additional wrinkles to consider due to the lender’s interests. Let’s look at how this works for revocable and irrevocable trusts.

How to Put a Mortgaged House Into a Revocable Living Trust

For most homeowners with an outstanding mortgage, a revocable living trust is the preferred route if the main goal is avoiding probate and retaining control during your lifetime. Here are the typical steps:

1. Review your mortgage terms for a “due on sale” clause Most mortgage contracts contain a “due on sale” provision that requires paying off the entire loan balance if the property transfers ownership. However, federal regulations allow an exception for transfers into a revocable living trust where you remain the beneficiary during your lifetime.
2. Transfer the deed to the trustee of your revocable trust You will execute and record a new deed conveying ownership of the home from your individual name into the name of the trust (e.g. “John Doe, trustee of the John Doe Revocable Living Trust dated…”). Depending on your state’s laws, you may need to pay a documentary stamp tax or transfer tax.
3. Continue paying mortgage as usual and follow lender instructions After trustee ownership, you simply continue making monthly mortgage payments as before from the trust’s assets. Some lenders may require you to initially request their approval or sign an assumption agreement affirming the transfer.

Once the mortgage loan is fully paid off, the lender will issue a release or satisfaction of mortgage in the trustee’s name. The trustee (you or your successor) can then take steps to formally clear the property title.

Overall, this process for mortgaged properties is fairly straightforward with a revocable trust since you retain lifetime beneficial interests. The main benefit is avoiding probate upon your death, as the home and other trust assets can transfer directly to your heirs.

Using an Irrevocable Trust for a Mortgaged Property

Putting a mortgaged home into an irrevocable trust is more complex, as you are permanently removing your ownership interests and rights. The typical steps are:

1. Set up an irrevocable trust via a trust document You establish an irrevocable trust through a legally binding trust agreement or declaration. This spells out the trust purpose, named beneficiaries, successor trustees, and core terms that cannot be easily modified once created.
2. Execute a secured promissory note for the mortgage balance To transfer the encumbered home into the irrevocable trust, you must give the trustee a promissory note secured by the mortgage loan. This represents the trust’s obligation to continue paying off the existing mortgage.
3. Change property ownership by executing a new deed Similar to a revocable trust, you will convey the home from individual ownership into the name of the trust by recording a new deed and paying associated taxes/fees. The trustee is now the legal owner.

Some additional considerations around using an irrevocable trust for a mortgaged property:

• Due on Sale Clause: Lenders may enforce the “due on sale” provision since you are relinquishing ownership rights, especially if not following required procedures like the promissory note above. Clear lender approval is strongly recommended.
• Arm’s Length Procedures: To avoid potential issues, the home transfer should be set up as a legitimate arm’s length transaction between you and the trust by properly executing the debt obligation and deed conveyance.
• Gift Tax Implications: Transferring assets into an irrevocable trust is considered a taxable gift above the annual exclusion amount (unless qualified transfers like payments of education costs). Discuss this with a tax professional.

So in exchange for the additional complexity, what are the potential benefits of using an irrevocable trust for a mortgaged property?

Advantages of an Irrevocable Trust

• Asset Protection: Assets inside an irrevocable trust receive strong protection from your future creditors, lawsuits or judgments against you.
• Remove From Taxable Estate: The home’s value is removed from your taxable estate, which can save significant estate taxes for high-net-worth individuals.
• Medicaid Planning: Assets in an irrevocable trust are not counted towards Medicaid eligibility limits for long-term care costs after 5 years.

Disadvantages of Irrevocable Trusts

• Loss of Control/Ownership: You permanently give up all ownership rights and control over the trust assets like your home.
• Difficulty Removing Assets: It is extremely difficult, if not impossible, to remove the home from an irrevocable trust once transferred in.
• Potential Tax Hits: In addition to potential gift taxes on transfer, you may owe capital gains taxes for property appreciation if removing from the trust.

As you can see, there are significant trade-offs to weigh between revocable and irrevocable trusts when your home has an outstanding mortgage balance. Getting guidance from qualified estate planning attorneys and tax professionals is highly recommended.

Consulting Professionals for Trust and Mortgage Guidance

Given the complex legal and financial implications involved, it’s crucial to consult the appropriate professionals when putting a mortgaged home into a trust:

Estate Planning Attorney

An experienced estate lawyer can walk you through the proper steps and documentation to establish the right type of trust for your situation – revocable or irrevocable. They ensure it is set up in compliance with federal and state laws.

“Putting real property in a trust is trickier when you have an outstanding mortgage, so it absolutely requires having an estate attorney review your mortgage documents first,” advises John Gamble, Esq. of Gamble Estate Planning Lawyers in Dallas.

Accountant or Tax Professional

You’ll want to understand the current and future tax implications of transferring ownership to trustees. A CPA or tax advisor can project potential costs from transfer taxes, capital gains, gift taxes, and changes to income/estate taxes.

Your Mortgage Lender

Don’t forget to review your specific mortgage documents carefully and notify your lender early in the process, even for revocable living trusts. Ask them about required procedures and paperwork to handle the transfer of an encumbered property.

“Most lenders will allow revocable trust transfers since the borrower remains the lifetime beneficiary. But notify us first, as we often just require an assumption agreement to be signed by the trustee,” says Mary Thompson, VP of Residential Lending at Sunbelt Mortgage.

By taking a comprehensive approach with qualified legal and financial guidance, you can determine the best strategy and navigate the process correctly for putting your mortgaged home into a trust.

This protects your lender’s interests, avoids unintended issues or penalties, and ensures your estate planning goals are properly achieved.

Key Takeaways

• You can put a mortgaged home into a revocable or irrevocable trust, but there are important considerations
• For revocable trusts, review mortgage terms but lenders generally allow transfers if you remain the beneficiary
• Irrevocable trusts require more complex procedures like a secured promissory note to avoid violating the “due on sale” clause
• Revocable trusts allow you to maintain control but don’t protect against creditors or reduce your