Trusts are common vehicles in modern estate planning. Their flexibility, especially under Tennessee law, gives a lot of options for legacy planning. A core asset that trusts hold is real estate. Whether a primary residence or a rental, a trust is a tried-and-true way to manage real property. But can you place a mortgaged house into a trust without any problems?
The short answer is yes, in most cases. We’ll discuss why in this article. We’ll also provide some important caveats and things to think about if you’re considering placing a mortgaged house into a trust.
Why is There an Issue with Putting a Mortgaged House in a Trust?
When you purchased your house, there were many documents that you signed at closing. (Does your hand still ache from that?). Among them were likely two specific ones for the amount borrowed—a promissory note and a deed of trust.
The promissory note is the promise to pay back what you borrowed to buy the house. The deed of trust is the lender’s security interest in the property. It allows the lender to foreclose if you fall behind on payments.
Included in nearly all types of loan documents is what’s referred to as a “due-on-sale” clause. This allows the lender to call the entire balance of the note due if the owner gives the property to someone else.
That said, federal law carves out certain exceptions to this. These exceptions are what allow homeowners to place a mortgaged house into a trust.
The Garn-St. Germain Act
Congress enacted the Garn-St. Germain Act in 1982. This law allows homeowners to transfer mortgaged property into a living trust without the risk of the lender calling the loan. Specifically, the Act prohibits lenders from accelerating the loan when a borrower transfers a mortgaged house into a trust of which they are a Beneficiary.
That is, if you are the Settlor of a living trust and are also a Beneficiary, the lender cannot demand payment of the remaining balance just because you placed the house into the trust. This federal statute provides homeowners with the flexibility to engage in estate planning without the fear of triggering adverse financial consequences.
The Act also protects certain transfers of real estate to spouses or children, though such transfers may be inadvisable. Putting an adult child’s name on the deed to your house may seem like a good estate planning strategy, but it comes with significant pitfalls. We discuss that topic here.
Rental Property and LLCs
While federal law provides flexibility placing a house into a trust—whether a primary residence or rental—that does not mean the law protects against all transfers.
For example, let’s say you have a rental house and want to place it into and LLC. Let’s also say your living trust is the LLC’s member (owner). While the trust is LLC’s owner, the LLC is still a different legal entity from you as the trust Settlor. The Garn-St. Germain Act would not apply to a transfer of that rental property into the LLC.
How would a lender find out about this transfer? A deed is effective upon your signature. But it’s filing with the Register of Deeds that provides public notice of new ownership.
The lender may see the title transfer to the LLC. It would then have the right to call the entire loan balance due. Not a good spot to be in.
Not all lenders would do this. Some may just want to see the monthly payments made and not care about a different name on the deed. But it’s a risky move to take without proper planning and due diligence.
One way to avoid a legal and financial mess is to obtain lender consent to the transfer. The process to obtain consent often involves providing information about the LLC, its structure, and how the change affects property ownership.
While this can be a quite bureaucratic procedure, it’s a necessary step to protect against substantial complications down the line.
Steps Needed After Placing a Mortgaged House into a Trust
Even though the lender cannot demand that you pay the entire balance after placing your mortgaged house into a trust, this is not the end of the story. There is still some homework you need to do.
It is imperative to update your homeowner’s insurance policy. For a husband and wife who own a house jointly, you typically would both be listed on the policy. But if the house goes into the trust, you two are not technically the owners anymore. The trust is now the owner of record.
If there is a discrepancy between title and the insured parties, the insurance company could deny an otherwise legitimate claim. What is likely the best path is to call your insurance agent and add the trust as an additional insured. Each carrier will have different procedures for this. So check with your agent so that you and your home remain protected.
It is still wise to notify the lender of the change, noting that this is your living trust. This keeps everyone’s records up to date.
Final Thoughts on Mortgaged Property and Living Trusts
The Garn-St. Germain Act is a great piece of legislation for homeowners and their estate plans. Whether mortgaged or not, you can place your house into a living trust without the threat of having the entire loan becoming due.
A trust-based plan is a wise choice for many people. But it’s not right for everyone. Each household should review their situation with estate planning and financial professionals to determine what is best for them.
Connell Law, PLLC provides residents of Rutherford County and the surrounding area with estate planning services. We frequently assist our clients with putting real estate into a living trust. To determine if this is right for you, reach out today to schedule your free consultation.
