What if I Inherit a House with an Underwater Mortgage?
Even though the information on this web page is provided by a qualified industry expert, it should not be considered as legal, tax, financial or investment advice. Since every individual’s situation is unique, a qualified professional should be consulted before making financial decisions.
In this guide, we will discuss 8 options you have in a situation when you inherited a house with an underwater mortgage.
These are the tactics and options I have walked my clients through to get them out of this sticky situation.
Let’s start with the explanation of the two most basic options you have.
I Inherited an Underwater House with a Mortgage — Now What?
There are two main options you have in this situation:
- not keeping the house
- keeping the house.
Now, here are the basic things to keep in mind before we start discussing each of the two aforementioned options and eight scenarios to complete them.
The house, as well as other estate property, will normally have to go through a probate procedure, whether or not the deceased left a will. A probate is a procedure of settling all debts the deceased has (if necessary, then by selling some of all of the estate assets) and then distributing the rest of the estate assets to heirs and beneficiaries.
Until the deceased’s debt is either paid off, eliminated or assumed by yourself or another person, you can’t become the legal owner of the house.
This also means that until the title to the house is transferred to you, you aren’t responsible for the mortgage attached to the property. If the deceased is behind in payments or even the house is in preforeclosure, your credit won’t suffer, until you become the legal owner.
If you are keeping the house, you will have to also assume the mortgage together with the title to the property. The mortgage contract may have a clause obliging the borrower to pay the whole remaining loan amount at once when the property changes the owner.
However, this clause won’t work in an inheritance situation. The law forbids lenders to change mortgage terms as well as demand the full remaining loan balance when an heir assumes the property with its loan.
It’s important to mention that some of this information may partially differ from the rules in your state and omit some of the possible opportunities you may have to resolve your situation. For the most relevant and complete advice, contact a licensed estate or probate lawyer in your location.
Option #1: Walk Away from Your Inherited Home
If you don’t want to keep the inherited underwater home, you have a few solutions. Let’s discuss them one by one.
Solution #1: Let the Property Go into Foreclosure
The heir to the property is not legally obligated to accept the home. If you decide to not accept a property with a mortgage that you have no way or desire to pay, you do not have to accept. You can walk away and let the bank take over the home via foreclosure. There will be no need to pay the mortgage and your credit will remain unfazed.
However, foreclosure is conducted over a certain period and according to certain rules. It can be a long process. You can learn more about it from this article by A.C Capital. But the bottom line is that the bank will have to sell the property via an auction and keep the proceeds.
If the property sells for less than what the mortgage balance is (which is highly probable because the house is underwater), then the lender will have to recoup these funds from the deceased’s assets. This could affect the amount of possible inheritance you and your family will receive.
Fortunately for you, if you allow the property to go into foreclosure, this will have no impact on your credit as long as it has not gone through probate. The deficiency amount (the difference between the sale price and the full outstanding mortgage amount) and negative credit outcomes of foreclosure will be associated with the deceased’s credit report, not yours.
However, depending on your lender’s position, they could withhold other estate belongings to make up for the deficiency amount. So you will have to wait until the end of the foreclosure process to receive any other property from the estate.
Solution #2: Negotiate a Short Sale with the Lender
A short sale is when the lender will allow you to sell the house for the current market price even when that number is lower than what is on the mortgage balance. A short sale is up to the mortgage lender to approve. For general understanding of what a short sale is, read our Short Sale Guide for Homeowners.
Will a bank accept a short sale offer on an inherited house with an underwater mortgage? It probably will. But if the deceased has other assets in the estate, the lender will go after them to compensate for the deficiency balance.
Sometimes the deficiency balance can be forgiven. This often happens when a person going through a valid and proven financial hardship short sells their own (non-estate) home. They simply can’t pay the deficiency amount. So the lender forgives it in exchange for helping them liquidate the property without making them go through a complicated foreclosure procedure.
Theoretically, the deficiency amount can be forgiven if the deceased has no other assets in the estate. However, in this situation, there is no obvious benefit for you to short sell the property rather than just walk away from the estate.
To sum up, it may make sense for you to short sell the inherited underwater home if there are other estate assets you are waiting to receive and their value is higher than the deficiency balance. This way, if a short sale is done professionally, it may save you time. You will get the rest of the estate property sooner than if you waited through the foreclosure process.
However, if a short sale is done unprofessionally, it can take up to a year (and even longer, depending on the level of incompetence of your real estate agent or short sale processor). The best way to complete a short sale is to use one of the best short sale processing companies in your area (also called short sale negotiators).
Their services are often free for sellers as they are compensated by lenders. Learn more about these experts from our article What Does a Short Sale Negotiator Do for the Seller?.
And if you are ready to get a free consultation, fill out this quick online form to get contacted by a reputable professional in your area vetted and approved by HouseCashin.
If you do a short sale after accepting the title to the inherited home, your credit will be seriously damaged, even though less than by a foreclosure. To learn more about the credit impact of a short sale, read our article How Does a Short Sale Affect Your Credit Report?.
Once legally owning the property, to qualify for a short sale, you must be a few months behind on mortgage and be in a valid financial hardship that you can prove to the lender. Accepting the home ownership just to a short sale later is not a good idea.
Solution #3: Improve and Sell the Property
If you want to avoid involving the bank in your transaction, you can sell the house traditionally. This can be done before the probate is settled or you can accept the title to the underwater home and sell it after that. Learn more about the rules from our detailed guide on selling an inherited home.
To meet the price that is needed to pay off the balance on the mortgage, you could add value to the inherited property and sell it for its new market price. Repairs and improvements can increase the value which will solve the problem.
You receive a property that is worth $100,000 in current market condition.
The property has a mortgage on it for $150,000
The remaining balance is $125,000.
If you invest $5-10,000 in repairs and improvements, this could force appreciation on the house making the new market value $135-145,000 depending on what is done. Then, if you decide to sell, you can take all of the proceeds from selling and pay off the mortgage which would result in a smooth transaction freeing you from debt.
The benefit to this is that you can add a small amount of money to force appreciation to get out of the situation while leaving your credit and personal finances unfazed.
If you aren’t experienced in home improvements and their impact on property value, it’s better to get consulted by one of the top-rated real estate agents in your area. They know what improvements will make sense as a value-add depending on the type, price category, and location of your property.
Otherwise, you can invest in unnecessary improvements that will not only add zero value, but will also make the house harder to sell.
Solution #4: Offer a Deed in Lieu of Foreclosure
Another option that an inheritor could take is to offer a deed in lieu of foreclosure to the lender. This is usually a last resort after you have tried all other options (except for foreclosure, of course).
A deed in lieu of foreclosure is a process where both parties (homeowner and lender) agree to transfer ownership of the home to the lender in exchange for a release of the obligations involved under the mortgage. To learn more deeply what a deed in lieu is and how it’s different from foreclosure, read our article Short Sale vs. Foreclosure vs. Deed in Lieu: Difference, Pros & Cons.
If you achieve it without taking the title to the property, this solution could be more beneficial for you than foreclosure. Waiting for the sale of the house through a foreclosure auction can be avoided. You can access the other estate property sooner. But the deficiency balance will still have to be paid from the deceased’s estate.
If there are no assets in the estate to fully or partially compensate for the deficiency balance, then, as stated in the short sale section of this article, simply walking away from the estate is an easier option.
If you have already acquired the property, a deed in lieu will do a significant damage to your credit score, almost like a foreclosure.
Option #2: Keep Your Inherited Home
Although you may inherit a house with an underwater mortgage, that does not mean you need to get rid of the property. If you can afford to keep the property and make the payments, you can do so. The federal law forbids the lender to change the terms on the mortgage when you inherit it.
Solution #5: Build on Your Property’s Equity
Before you decide to dump the property, see if there is a way you can continue paying the mortgage on the inherited house to build equity. If you have enough income to do so, this would allow you to stay in the driver’s seat by paying down the mortgage and gaining another asset.
If you are close and could make it work by reducing the payment by a small amount, this would be the time to reach out to the lender and inquire about assistance or loan modifications.
Solution #6: Refinance the Mortgage
A possibility that could make sense is to refinance the mortgage to keep the house. This tactic could allow you to keep the house and, depending on your local market, probably take advantage of low interest rates which will save you a significant amount of money.
Another perk would be to switch to a fixed-rate mortgage (FRM) if the current one is an adjustable-rate mortgage (ARM). This would allow you to be locked in at a great rate and provide consistent predictable payments for the years to come.
Solution #7: Modify the Loan
A loan modification can change the monthly payment to something more suitable for you. Talk to your lender and see if there is something that could be worked out that would result in a mutually beneficial agreement.
Solution #8: Rent Out the Inherited Home
Renting out the inherited property is a great way to avoid the hassles that come with selling while being able to build equity. Make sure if you are deciding to rent, that your loan and terms are in order.
Some banks will allow you to assume the loan, while others may force you to refinance into a new loan. If you don’t qualify for a new loan, renting may not be an option for you. If you rent out the property, you can collect the cash flow that the property generates and pay down the mortgage quicker or create another stream of income for yourself.
Renting the property out is a great way to keep the house if you do not possess the money to pay for another mortgage.