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Ask Farnoosh: Who’s Responsible for Mortgage Debt After Death?

Tracy asks on Facebook: I just purchased a new vehicle in May 2012 and I will not be able to afford it any longer due to all of my other bills. Will it affect my credit if I take it back to the dealership? I've never been late.

The act of taking a car back to the dealership is called a “voluntary repossession,” which still leaves you financially liable and could damage your credit score by as much as 75 to 100 points, says Gerri Detweiler, a credit expert with Credit.com.  “It’s not as simple as giving the keys back to the lender or dealer,” she says. When you return your vehicle to the dealer because of financial troubles, it usually gets sold at an auction for a fraction of what you paid for it. From there, you’ll still be on the hook for the deficit, the difference between what you owe on the loan and what the vehicle sold for at auction. “The lender or a collection agency can try to collect the deficiency, and may eventually sue you if you are unable to pay it,” continues Detweiler.

Before handing in the keys, consider these alternative steps. First, talk to your lender about refinancing or modifying the loan. Maybe you can ease the monthly payments by obtaining a lower interest rate or stretching the loan’s term.  According to researchers at Edmunds.com, your bank may also provide some wiggle room by letting you to defer your payment by 30 days. If you really can’t afford the car beyond that, see if you can sell it on your own for the best price possible. Chances are you can do much better than an auction house and end up with a smaller deficit when it’s sold, which will be due before you can transfer the car to a new owner. 
 
Rich emails: My mother is 80 years old and a widow. Her home is underwater. The mortgage is relatively low, about $700/month, due to HARP assistance. It's basically a 40-year loan, with about $185,000 loan balance, with a balloon payment due, I believe, in 30 years. Should my mother pass away, will the debt pass away with her, even though she may bequeath the house to me or one of my other 3 siblings? Neither I nor my siblings need the house, since we own our primary residences. None of us is interested in being landlords, either. Her estate consists of a small home, an automobile, and checking/savings. She lives on Social Security.

Hi Rich,

I applaud you for being proactive, learning the ins and outs of your mother’s financial obligations, especially if you’re concerned some may become your responsibility down the road.
 
Your mother’s mortgage will not “disappear” after she passes. Depending on the terms of her loan, it’s not unusual for a mortgage to be due in full upon the borrower’s death.  But of course, even if that is the case with your mom’s contract, unless she has $185,000 sitting around in a bank account, paying it off will obviously not be possible.
 
If your mother has designated an executor to her will (and I hope she has) -- someone to manage her finances after she dies -- this person may work with the lender to sell the home and pay off the mortgage. In most of these cases, it’s done through a short sale where the home price is negotiated at a fair market value that’s established through an appraisal, according to California realtor and short sale expert John A. Silva.
 
If the proceeds from the sale are not enough to fully pay off the home loan, as the home is underwater, then the lender may come after your mom’s estate to collect the rest. But again, without sufficient funds in her accounts, the bank may have no choice but to settle. Even if she bequeaths the home to you or a sibling in her will, unless you intend to keep it, you’re not obligated to pay the mortgage in most states. You can, essentially, give the home back to the bank and let them deal with it. “If it’s upside-down, you just let it go to foreclosure. That’s the recommended course of action,” says Silva.

There are some steps your mother can make now to avoid the drama and legal costs associated with managing her estate in the event of death. If she hasn’t already, one key move is to create a will outlining how she would like to transfer her assets and to designate an executor (perhaps you or someone else she trusts). Have an honest discussion with her about how it’s not necessary (or preferred) to leave the home in any of her children’s names. “She’ll have to state plainly in her will that she doesn’t want the property to transfer to her relatives,” says Kraig Kast, managing trustee at California Trust Co. in San Mateo, Calif. To avoid probate, which is the legal – and often lengthy and pricey -- process of determining a will’s validity upon death, your mom may also want to establish a living trust.
 
“When an estate goes to probate, you pay court costs, attorney’s fees… I’ve seen estates worth just a few hundred thousand dollars get swamped with probate fees,” says Krast. For a small estate like hers, an attorney could prepare a living trust for about $400-$600, he says, or sites like Nolo.com or LegalZoom can produce one for $50 to $80.
 
Got a question for Farnoosh? You can reach her on Twitter @Farnoosh or email her at farnooshfinfit@yahoo.com.

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