Financing Probate and Trust Property: What to Consider When Qualifying a Borrower

By Rick Harmon, The Suburban Group - Mortgage Bankers

An overview of the major factors which may be used in qualifying probate or trust owned property to finance estate debt, pay attorney fees and to buy out other heirs' interests.

Who's The Borrower?

Achieving your client's financing goal will largely depend on how they will sign for the loan. The key to remember is that how they will sign makes a difference to the lender, a big difference. That is to say, will the borrower be signing on behalf of the estate or personally?

Vesting: How Does Borrower Hold Title? Individual or Fiduciary?

Early in the loan process, it must be communicated to the lender how the borrower intends to hold title. This single factor can make a significant difference in the availability of loan programs and the resulting choices. Singing personally will require that the borrower have title to the real property at the time of recording the trust deed, whether the transaction be a purchase or distributing estate property.

To Qualify a Borrower...Whats Needed?

The answer, you probably correctly guessed, depends on the loan the borrower is applying for and how they intend to hold title. Those persons wishing to borrow as an estate fiduciary will be pleased to learn that equity and the condition of the real property will be the primary factors used qualify them for a loan; their credit and income are less important under these circumstances.

Borrowers who will ultimately vest title as an individual at time of funding and who want the best rate and terms will want to qualify for a conventional mortgage. Borrowers who have some credit problems and/or hard to prove/limited income may still qualify for a mortgage at attractive rates and terms, however, these terms will not be the same as for borrowers with established, perfect credit and significant income from documented sources.

What is important to understand is that the loan applicant must meet the minimum requirements in each category; it rarely will help to fit into a given program if any single guideline is not met, even if certain other guidelines are exceeded.

Character and Credit

Credit repositories like Experian (formerly TRW), Equi-Fax and Trans Union are reporting agencies and never make any lender recommendations, favorable or otherwise. They merely provide a history (if a credit history exists) of the applicant's credit experiences, as reported, to the various subscribing creditors. Not all credit information will be reflected on all credit reporting agencies and likewise, not all information present may be accurate. In the case of the later, the burden of proof, unfortunately, rests on the applicant to correct the erroneous data.

If credit is often a good predictor of an applicant's future payment habits, how can derogatory credit be interpreted? One of the surest ways to see if the problem is/was driven by a certain event or the normal payment habits for the applicant. The lender will review the credit report to determine if the timing is grouped, isolated late charges, collections, if the bills were medical related, a bankruptcy (if a 13, was the plan completed?), or a foreclosure. It may surprise some to learn that a client with a prior bankruptcy who kept a mortgage current is held in fairly high regard among lenders.

Income

How the applicant makes a living is not as important as how they are paid, how much, the likelihood of their continuing to receive the same or more income and if it is verifiable. Wage earners tend to have an easier time proving income. Some complexities arise when qualifying self employed applicants who tend to make substantial deductions from income taxes. Also, in the ever-changing employment environment, more persons are employed as consultants.

Debt Ratios

Formulas called debt ratios can neatly calculate the availability of income to make payments on monthly housing expenses (mortgage, taxes, insurance, utilities, upkeep, etc.) and other consumer debt (credit cards, auto loans, etc). Conventional and other institutional lenders will use these formulas to qualify a borrower. Equity lenders, however, will not weigh debt ratios importantly when qualifying the borrower. These lenders will adjust the amount they may lend downward on a particular home if the applicant's situation warrants it.

Savings

What is the applicant's likelihood to survive a financial setback or reversal? Possessing a savings account having at least a minimum of one or two months mortgage payments may be required for certain loan programs. The lack of such funds may raise other lending concerns.

Down Payment or Equity Source

If the proposed loan is intended to fund the purchase of property, it is presumed that, under most all conventional lending guidelines, the borrower will be required to ultimately have a certain percentage of protective equity in the subject property. This could be as low as 3-5% for certain programs to as much as 20% or more, depending on the applicant's situation.

In the case of a probate estate "buy-out" the applicant is typically an heir who desires to buy out other heirs' interests, but puts no cash of their own into the transaction. This can be documented in such a manner as to should the distributive share as a paper down payment. Gifts from others can also be documented, such as a parents help with a down payment.

The Security

Since the security for any mortgage is the real estate, it comes to reason that lenders will pay close attention to the property and the improvement. Lenders will scrutinize the property value, protective equity, and determine a maximum loan-to-value ratio ("LTV") that they will limit their loan to. Another big factor is the propertys marketability which refers to the probability that a property can be resold in the event it reverts to the lender.

Property Types

• Single Family Residence or "SFR" are the most marketable properties and the least likely that an owner would prefer lose and lenders will usually make the highest "LTV" loans.
• Condos and townhouses are frequently more difficult to sell qualify for high LTV loans.
• Small residential units (duplex, triplex or four plex) may still fit the conventional lending guidelines to qualify for up to 90% LTV loans IF the owner resides in one of the units.
• Five residential units+ are considered investment income property. Loans go to 75% max.
• Mixed use (residential & commercial) are treated on case-by-case basis; expect 65% LTV
• Commercial properties run a wide variance and can command 50-90% LTV financing.
• Vacant land, mountain cabins, homes in graffiti war zones can be very hard to finance.

Property Quality Grades (for Improved Properties)

These classifications relate primarily to the original design, the quality of construction, age and condition of a property. While not a universal classification system used by all lenders, the following basic A-D guidelines help to better communicate the grade of the subject property.

"A" properties generally refer buildings that are of a superior design and construction and are maintained accordingly. This would be appropriate for a building that consisted of very high grade finishing materials like marble and granite and is maintained to the highest standard, such one would find in high rent urban and exclusive communities.

"B" properties are well built and well maintained, but are not gold-plated trophy buildings or mansions. These properties are very appealing and often command high rent, but not "A" grade due to age, management, location or a lack of grandeur.

"C" properties are average in design, appeal and construction and are maintained sufficiently to satisfy most lenders. Properties in this category may show some wear but nothing major.

"D" properties may be older (pre-WWII) or just poorly maintained and threadbare. Also in this category may be Sub-standard properties which may well require modernization, rehabilitation, seismic upgrading or other work to comply with lender's guidelines.

Q & A About Mortgage Financing for Probate Estates and Trusts

Q. If I sign for a mortgage loan on property owned by the estate as executor of administrator, am I personally liable for this loan?

A. No. You are responsible to the estate in your fiduciary capacity that you sign, i.e., as the personal representative of the estate, but a late payment (nor a default) will affect your personal credit history. This does imply that you have certain duties to act in a responsible manner with the money the estate has borrowed, maintain a high level of trust for the benefit of all parties concerned (including the attorney, creditors and bonding company, if applicable). You must plan to be accountable for how you use the loan proceeds.

Q. Can I use the money for myself?

A. If you are borrowing as a fiduciary, the money belongs to the estate until the court permits some or all of the proceeds to be distributed. If you are borrowing individually and signing for your loan personally, title to the property will have been put in your name on or prior to your loan having been completed. In that case, any proceeds (cash out) is yours to use as necessary unless, as condition of receiving that loan, the lender limits how the funds are to be used.

Q. What arrangements can be made if the executor or administrator cant afford to make monthly payments?

A. One of the benefits of using equity financing is that it often permits more flexibility in structuring a repayment plan. For instance, an estate with sufficient equity in the property may borrow and request that future payments from several months to years be made in advance to insure that payments are provided for, until other arrangements are made.

Q. Are mortgages assumable?

A. Mortgages made to executor, administrators or other fiduciaries may be assumed or payments taken over by heirs, but not usually by third parties. Some FHA loans made to individuals to purchase estate property may be assumable after qualifying and a small fee.

Q. Can I buy out another heir when I dont have any cash for a down payment?

A. You may be able to buy the property from the estate using your distributive share in the estate or trust (your inheritance). Heirs can sometimes use this share just like a down payment, depending on the value of this share relative to the loan youll need and your ability to qualify for a loan (just like any other buyer). Every estates situation is unique, so your chances of obtaining financing will largely depend on how much you equity you will ultimately have in this property, your credit and income strength as a borrower, and the level of experience and understanding your lender has in obtaining financing.