Inheriting a mortgaged property

[Peanutte]

What is the situation regards leaving a mortgaged property to someone in your will?

Background: I have some rental properties and I would like to leave one or two to each of my children. The properties are all mortgaged and all have reasonable equity in them.

Would the offspring have to apply for new mortgages? They could probably pass 'affordability' for one if the mortgage was joint with a partner, but possibly not for two or more at once.

My idea in passing the houses on to them is that there would be a future income from the rents plus capital appreciation. Or they could sell them if they wished.

They all have their own (mortgaged) homes, so would not wish to live in the properties.

Thanks,

Peanutte.

[swill453]

I think in essence your executor will have to settle the estate's debts before making distributions to inheritors.

Whether there's a way of the inheritors getting a mortgage themselves to pay that debt I'm not sure, but it sounds like a can of worms.

Scott.

[gryffron]

In principle I agree with Scott. Your estate's debts must be settled before benefits are distributed.

However:
There's nothing to stop the ultimate beneficiary from BUYING the property from the estate. I don't see any reason why the will should not offer them first refusal, obviously at a discount cos they expect to own the residual value anyway. Ultimately - they are buying the property from themselves - so there would be no "loss" for the executor to worry about regardless of what they contrive to pay. So provided they pay sufficient money to clear the mortgage, what's the problem?

The only downside I can see is the beneficiary would be purchasing the property from the estate rather than inheriting, and thus subject to Mr Osborne's second home stamp duty. Not sure how you can avoid that if they have to pay money towards it. Still a cheap property though - if that's what they want. Have you discussed with your children whether they actually WANT to keep these properties. Because if not, you could just be adding unnecessary complications.

Gryff

[Lootman]

There's nothing to stop the ultimate beneficiary from BUYING the property from the estate. I don't see any reason why the will should not offer them first refusal, obviously at a discount cos they expect to own the residual value anyway. Ultimately - they are buying the property from themselves - so there would be no "loss" for the executor to worry about regardless of what they contrive to pay. So provided they pay sufficient money to clear the mortgage, what's the problem?

It would be simpler, and avoid stamp duty, if the beneficiary simply paid off the mortgage with his/her own funds, and then inherit the property free and clear.

At least, that is what I did in a similar situation. Rather than have the estate pay off its debts, I paid them off outside of probate. It made probate simpler and quicker, and of course the end result was exactly the same.

Creditors are always happy to be paid regardless of the source.

[Peanutte]

Thanks for your responses. More complex than I realised.

No I have not discussed it with them - I thought it would be better to see if it would be possible first.

Perhaps I might gradually slim the portfolio down and pay off the mortgages - so I could leave them one each owned outright.

Thanks again.

[Clitheroekid]

I think in essence your executor will have to settle the estate's debts before making distributions to inheritors.

Whether there's a way of the inheritors getting a mortgage themselves to pay that debt I'm not sure, but it sounds like a can of worms.

This is entirely wrong.

The position is governed by section 35 Administration of Estates Act 1925. It states quite clearly that where someone leaves a gift of land subject to a mortgage that mortgage is the sole responsibility of the beneficiary, and it must not be paid as a general debt of the estate.

An executor who did pay off the mortgage from estate funds would be liable to reimburse the other beneficiaries out of his own pocket.

The testator can overrule this provision in his Will by specifically stating that the mortgage debt is to be paid out of the estate generally, but the instruction to do so would have to be in very clear and unambiguous terms.

So to answer the OP's question if you simply leave the properties individually to your children the children will all become individually responsible for the mortgages on those properties.

In practice I would expect the mortgage lenders to demand repayment, on the basis they had never agreed to lend to your children, in which case they would have to re-mortgage or sell. However, I suppose it's possible that the lenders might agree to leave the mortgages in place - a lot would depend on the individual circumstances.

From a purely practical point of view it might be worth considering taking out appropriate life insurance cover to pay off the mortgages if you died before they'd been paid off. Assuming you're in reasonable health such cover is extremely cheap for the peace of mind it provides.

[Clitheroekid]

And as a PS it may go without saying that you should not for one moment contemplating making your own Will in a situation like this, as the consequences of getting it wrong could be disastrous.

[Lootman]

From a purely practical point of view it might be worth considering taking out appropriate life insurance cover to pay off the mortgages if you died before they'd been paid off. Assuming you're in reasonable health such cover is extremely cheap for the peace of mind it provides.

Question. Would an insurance policy paying off the mortgages upon death not increase the inheritance tax that would be due? The mortgages reduce the net value of the estate, and therefore the IHT due. So for example if the insurance pays off a 100K mortgage then that increases the IHT by 40K, meaning the real value of that payoff is 60K, not 100K?

You said such insurance is cheap but I would have thought that depends. For an older person I would imagine such insurance might be quite expensive.

[Clitheroekid]

Question. Would an insurance policy paying off the mortgages upon death not increase the inheritance tax that would be due?

No, as the benefit of the policy in a case like this is assigned to the beneficiary (the one who is going to have to pay off the mortgage) and the policy proceeds do not, therefore, form part of the estate for inheritance tax purposes.

Another advantage of this is that the beneficiary can receive the money immediately after death, without having to wait for probate.