Frequently, the personal representative of a probate estate is confronted with the situation where the decedent died owning real property (often the decedent's home) encumbered by a deed of trust (mortgage). Often, the real property is the only asset of the estate that has any significant value. It is therefore incumbent on the personal representative to understand how the mortgage affects the administration of the estate and how failure to make timely payments on the mortgage during the estate's administration can result in the loss of the real property to the lender through foreclosure.
Why Do Estates Default on the Decedent's Mortgage?
Estates typically default on a decedent's mortgage due to one or more of the following reasons: (1) the encumbered property is the only asset of the estate and there are no other funds in the estate to pay the mortgage; (2) the personal representative is unaware of an encumbrance on the decedent's property and simply fails to make payments; (3) the personal representative assumes that the loan does not have to be repaid during administration of the estate or the loan is forgiven due to the decedent's death; (4) the property is worth less than the loan secured by the property.
The Estate Must Continue to Make Payments
If an estate owns property encumbered by a mortgage, the estate must continue to make payments on the mortgage under the terms specified in the mortgage, or risk the possibility of foreclosure. There are no exceptions under California law that mandate forgiveness of the loan due to the borrower's death. Neither is there any law that allows the estate to defer payments to the lender until the property is sold. If the estate defaults on the mortgage during the period of the estate's administration the lender can foreclose on the property.
Liability of Estate Assets for Default
If the lender initiates foreclosure, the estate has no personal liability if it is a "purchase money mortgage". In other words, in order to satisfy the debt, the lender must look exclusively to the property securing the debt. If the proceeds received from the foreclosure sale are insufficient to pay off the loan, the lender cannot obtain a deficiency judgment against other assets of the decedent's estate. This rule applies to all real property secured by a purchase money mortgage if the lender was also the seller of the property. If the lender is a third party, e.g., a bank, it applies only if the property was an owner-occupied dwelling of no more than four units.
If the debt secured by the property is not purchase money, the estate may be liable for any deficiency. However, the lender cannot pursue a deficiency judgment against other estate assets if they foreclose on the property under the power of sale granted to them in the mortgage, often known as a trustee's sale or non-judicial foreclosure. Because non-judicial foreclosure is the usual method of foreclosure, instances of estate liability for deficiencies after sale of the property are rare. If the lender desires to preserve their ability to recover against estate assets they are limited to one option - judicial foreclosure. In a judicial foreclosure scenario, the debtor, and hence the estate, would be liable only after the property is first applied to the debt. The lender cannot simply sue the estate.
Lender Must File a Creditor's Claim to Pursue a Deficiency Judgment Against the Estate
A lender who wishes to pursue his or her right to a deficiency after a judicial foreclosure must still file a creditor's claim against the estate for the potential deficiency. If a sale of the foreclosed property results in a deficiency and a judgment is entered, the lender can amend his or her creditor's claim to reflect the amount of the deficiency, and then proceed against the remaining assets of the estate. However, since judicial foreclosures are relatively rare occurrences, the remainder of this article discusses non-judicial foreclosures.
In California, the non-judicial foreclosure process is conducted pursuant to Civil Code ? 2924. Section 2924 authorizes the lender, in the event of default, to sell the property to satisfy the loan balance. If the power of sale clause includes the time, place and terms of sale, then that procedure must be followed. If not, the process is as follows: (1) Day 1 - notice of default is recorded the county recorder's office where the mortgaged property or some part thereof is situated; (2) Day 91 -- notice of the foreclosure sale is given; (3) Day 106 -- last day to reinstate mortgage by paying all past-due amounts plus and expenses of foreclosure process; (4) Day 111 -- foreclosure sale. As can be seen from the foregoing a non-judicial foreclosure can take as few as 111 days from start to finish.
What To Do if the Personal Representative Receives a Notice of Default
If the personal representative receives a notice of default he or she has limited options. The first and perhaps the obvious step is to call the lender in order to talk with someone with the authority to stop or even forestall the foreclosure pending the sale of the property. Ideally this conversation should be initiated early on in the probate proceedings if the personal representative has any concern about making the mortgage payments because finding the person with the authority to stop or forestall the foreclosure can be a difficult and time consuming process. Banks are notoriously slow at responding to requests and are often inflexible on loans once advised of opening probate.
Seek to Enjoin the Foreclosure
If the lender is unwilling to stop the foreclosure process the personal representative can enjoin the foreclosure until the property can be sold to satisfy the lien. One argument to make in support of an injunction request is lack of proper notice of the foreclosure sale. Since the trustee named under the mortgage is responsible for noticing the pending foreclosure sale on behalf of the lender, communication with the lender at the outset of the probate administration should be documented thoroughly. A simple way of documenting communication is to send all correspondence by certified mail. That way, if the lender initiates a foreclosure without having properly noticed the personal representative (after being informed of the probate), the estate may enjoin the trustee/lender from any further action until notice is properly given. This could force the lender to start the foreclosure process over again, buying the personal representative more time.
If the personal representative believes that they can eventually sell the property for more than the estate might otherwise receive under a non-judicial foreclosure sale, he or she might consider borrowing additional funds from another lender as a temporary stop-gap until the property can be sold. This is not without its hazards however. The typical scenario might involve a family member of the decedent or a potential heir who is willing to lend the estate the funds to pay the mortgage in order to avoid foreclosure. Since the estate is presumably insolvent (why else would they be asking for another loan) any person who makes such a loan will likely have to wait until the property is sold before they can realize the interest on their promissory note and recoup their principal. Therefore this "angel lender" will undoubtedly charge a premium considering the inherent risks involved.
Further Risks to the Lender
In addition the angel lender may have little recourse against estate assets if the estate defaults on the loan because it is doubtful that the loan will be considered an expense of administration. Expenses of administration are costs arising from the necessity of administering the estate. These expenditures can be for items incurred by the personal representative for the preservation of estate property. Expenses of administration are generally entitled to be repaid first prior to general debts of the decedent and the estate. The preference given to administration expenses, however, applies to money directly expended by the personal representative on behalf of the estate. A third party lender who loans money to the estate in order to preserve estate property is generally not entitled to have their loan classified as expense of administration.
The Personal Representive Could Loan Funds Personally
If money is to be obtained a from a third party lender the personal representative might consider obtaining the funds personally from the lender and then loaning the funds to the estate. This should ensure that the debt is classified as an expense of administration and thus entitled to preference over general debts of the decedent and the estate. However, this also means that the personal representative, as the borrower, absent an agreement to the contrary, will be personally liable on the debt - a prospect which might not be palatable to the personal representative.
What Happens to the Proceeds From Sale
If the personal representative is able to sell the property prior to foreclosure, expenses of administering the property and the expenses of sale are paid before the secured creditor. If encumbered property is sold, the application of the purchase money shall be applied in the following order: (1) expenses of administration which are reasonably related to the administration of the property sold; (2) the payment of the expenses of the sale; (3) the payment and satisfaction of the amount secured by the lien on the property sold if payment and satisfaction of the lien is required under the terms of the sale. Any amounts remaining after payment to the lender to satisfy the mortgage will go to the estate.
Consider Filing a Petition for Application of Foreclosure Proceeds
If a foreclosure sale takes place, rather than a sale by the personal representative, the application of the proceeds would appear to be the same. However, the personal representative should remember that the trustee under the mortgage works for the lender and may be inclined to distribute the sale proceeds directly to the lender, leaving the estate with nothing. Given this scenario, it may be prudent to file a petition under Probate Code section 10361.5 for an order determining the amount of administration expenses related to the encumbered property. This will allow the personal representative to obtain reimbursement of estate expenses directly out of escrow, rather than facing the prospect of pursuing the lender for reimbursement.
In order to prevent foreclosure of estate property it is important to keep all secured loans current. If real property or any other property, owned by the decedent, is subject to a mortgage or other type of encumbrance, the personal representative should immediately write to the lender(s), inform them of the decedent's death and the personal representative's intentions regarding the property, i.e., whether the property is to be sold or distributed to the heirs. The personal representative should also inform the lender, in writing, of the address where future correspondence to the personal representative should be sent. Keeping the lender informed will lessen the chances of a potential foreclosure. In addition, should the estate default on the mortgage, there will be better justification to enjoin the foreclosure if the lender did not properly notice the personal representative.
Talk to the Lender Early
In addition, if the estate is insolvent and cannot afford to pay the mortgage, but there is equity in the property, inform the lender of the situation and tell them that you are diligently marketing the property for sale. The lender may grant you extra time to make the sale if you inform them early on in the administration of the estate. Alternatively, if the property cannot be sold or there is no equity in the property talk to the bank and see if they will accept a deed to the property in lieu of foreclosure. If the bank accepts this offer, it will lessen the likelihood that the lender will try and obtain a judicial foreclosure in order to pursue other assets of the estate.
Administrating estates with real property subject to mortgage balances is likely to increase given the recent housing bubble and mortgage crisis. While remedies do exist for estates to recoup some expenses of administration if a foreclosure occurs, it is undoubtedly better to prevent foreclosure in the first place. The investment of a little bit of time at the outset of the probate proceedings in dealing with a lender will ultimately pay great dividends if it means preventing foreclosure and making more funds available for the heirs and other creditors of the estate.