Mortgage your Inheritance? Probate & FAQs

Death of a loved one brings about many changes not to mention strong emotions. Often the kids are thrust into uncharted territory when a potential property inheritance or residual debt is involved. Whether a cottage on the lake, farm land, or a house in the city, this article is about how to best view the budding situation, dissect the issues, and how mortgage financing can potentially help out. It can apply where there is one party to many.

Whether a daughter dealing with the family farm, or the call I received the other day from a son and brother looking to understand what mortgage or buy-out options were available for a home he and his brother were about to inherit from their deceased father’s estate. The caller (also the Executor of the Estate) just wanted his share of the value in cash and the other brother wanted to keep the home as a rental and perhaps a future location for him to live with his family. The implied question was, if one party wants to keep an inherited property and the other wants to sell, what do you do? This applies in so many variations and combinations: they all want the property, no-one wants it, one does, some don’t - let’s avoid World War 3 if we can!

The first very important concept to understand is a little bit about the “probate” process. When someone passes, while physically deceased, they continue to exist legally until all their financial matters have been dealt with. Their legal identity is known as The Estate of - let’s say - Mr. Jones. So at the moment of passing, the owner of a property becomes the Estate of Mr Jones and any mortgage or other payment obligations that existed the day before Mr Jones passed, continue to exist the day after. The Executor of the Estate was either spelled out in Mr Jones’ ‘Last Will and Testament’ and/or granted by the courts, and the Executor’s job is to make sure payments continue to be made as they fall due and to quickly wind down Mr Jones’ financial affairs, including the disposition of any property. This process in Canada and most countries in the world is called Probate.

The first thing I mentioned to the caller was to keep clear in his mind that his role as Executor of the Estate is different and separate, and precedes his and his brother’s roles as "beneficiaries" of the estate, so he had to make sure what “hat” he was wearing. In the Executor “hat”, his job is to determine then pay off the Estate’s liabilities from the estate’s assets, then distribute any remaining proceeds or “residual” to the beneficiaries in the manner or percentage indicated in the Will, perhaps 50/50 in our example. The residual can be either cash or cash-in-kind (ex. a property worth $X). The value attached to any real estate assets shall be the ‘fair market value’ as determined by a licensed appraiser. This is a requirement of the Canadian Revenue Agency (CRA) also.

I explained to my caller that if his brother wanted the house and he didn’t, that brother could simply indicate to the Executor that he was interested in buying it from the Estate of Mr Jones. If brother as a beneficiary was entitled to half the value of the property, then he only needed to come up with the other half of the value to complete the purchase. For example, if the home is worth $400K and brother is entitled to $200K of the value, then brother needs to come up with $200K. Upon receipt of $200K from brother, the Estate of Mr Jones would transfer the title to brother, and then distribute the $200K to the other brother, in this case my caller. Voila!

That brings us to the next issue - how does brother-to-buy come up with $200K to complete his purchase from the estate if he doesn’t have the cash? The answer is - and this is a very salient point in any discussion about Wills and property disposition - whoever wants to acquire the property needs to be able to qualify to borrow the shortfall via a mortgage on the property or other form of loan. If s/he can’t, then the Executor's only remaining option is to sell the property and distribute the residual cash to the beneficiaries.

          Here’s a brewing example from another client to illustrate the same point. ‘Grandpa’ has just passed at 85 and ‘Grandma’ is close behind him. On her passing their orchard worth $800K is to pass equally to their 4 adult children. Two of them are okay with $200K cash each, and the other two are already ‘putting on the gloves’ as to why one should get the farm over the other. My advice was sought and my reply was simply that whoever wants the farm has to first prove that they can come up with $600K to buy the other 3 out! If they can’t come up with $600K (or don’t want to), then end of discussion - their only option is to get cashed-out.

So in both the examples above, it should be clear that the sibling-to-buyout the others needs to come up with money. Here are some of their options:

  • New mortgage against their own property, if they have one and can qualify (refinance/equity-take-out)
  • Mortgage against the inherited property, if they can qualify (purchase financing)
  • Swap property for cash or other assets they might otherwise inherit from the Estate
  • Sell personal assets, investments, perhaps RRSPs to come up with the required cash.
  • Convince one of the other siblings to provide them with a “private mortgage,” meaning regular payments are made over time, just like any mortgage. Mortgage is registered on the land title and helps to protect the sibling-lender*
  • Form a joint venture - convince the other sibling to share ownership of the property as as a joint investment**, perhaps as a rental property. Make sure to document the partnership rules from the outset in something called a Joint Venture Agreement.
  • Have your cake and eat it too...if both siblings agree to re-mortgage the inherited property, then can still get most of their cash out and own the property as a joint venture! Use rental income to cover the mortgage payments, and if structured correctly the interest payments are tax deductible and the cash can be used to reduce non-tax-deductible debts, like the mortgage on their own homes. (This is an incarnation of the Smith Maneuver).

In the options above involving a mortgage, the mortgage approval process is the same as would be for any purchase or refinance. The applicants must have stable employment, sufficient income, and sufficient credit rating. The down payment is viewed as gifted equity from the estate, and lenders will need to see the inheritance paperwork. The lender will also require the property value to be independently appraised, which can often be same appraisal report that the CRA requires.

A couple of footnotes/warnings:

* If one of the siblings agrees to provide a private mortgage to the other, make sure - as the lender - that you are comfortable with the credit risk of the other. Having to foreclose down the road on a property owned by a sibling for non-payment is a sure recipe for an ugly family mess. Best to not go there from the start. How to determine lending risk? Engage a mortgage broker to represent you as a private lender and properly assess the borrower. There is even a way for you to hold the mortgage in your RRSP if that would be desirable.

** If you decide to jointly own a property, understand the difference between the legal terms “tenants-in-common” and “joint tenancy,” and make sure you set up the right form. A Tenancy in Common means that if one of the partners dies, their share passes to their own spouse and/or kids. Joint Tenancy means the remaining partner gets the deceased partner’s share.

In summary, understanding that where there is an Estate with property and there are multiple beneficiaries to the Estate or the Estate has debts to discharge, any beneficiaries that want to keep the property may need to mortgage-qualify to acquire the title. Feel free to contact us if you would like to learn more about what mortgage financing options would be available in your specific case.

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As a twist to the above, I recently arranged mortgage financing and a transfer of a property from dad to his only child, and dad was still alive! Dad simply wanted his property title to transfer without the need for probate, incident or unnecessary disruption, and when he knew his son could mortgage qualify. Dad had a small mortgage balance to discharge and some property tax arrears to clear up under a “seniors property tax deferral program” available in his area, so by being proactive dad was simplifying and cleaning up his financial affairs and reducing his son’s future burden on his passing. He also got to see the equity in his home make life easier for his son, daughter-in-law and grandson.

This pro-active strategy would work equally well if the kids want to keep a property encumbered by a reverse mortgage.

If you have any questions, please feel free to contact us.