Extending credit that requires collateral to secure the transaction for legitimate purposes is common business practice. When the collateral presented to back the extension of credit is a living trust, more due diligence on behalf of the creditor is necessary. Borrowing from a living trust is possible, subject to where the borrower stands within the trust document and how the creditor applies prudence to ensure that the transaction does not violate the trust and remains protected during the life of the credit agreement.
What Is a Living Trust?
A living trust is an estate-planning tool that is designed and implemented to ensure the passing of title to assets without the need to go through the probate process. Three parties are associated with a living trust.
Who Is Involved?
A grantor is the person who owns the assets to be passed on. This person creates the trust by the donation of the assets to the trust, which are to be transferred in accordance with the terms. A trustee is the person who administers the trust. The trustee has control over the disposition of the assets held in the trust and acts in the best interests of the trust at all times. The beneficiary is the person who will receive the assets from the trust when the triggering event occurs. For example, the trust is designed to pass the assets of the trust to the beneficiary in the event of the death of the grantor.
A living trust is also revocable by the grantor. This allows the grantor to make changes or eliminate the trust in entirety
Determining where the prospective borrower stands in the trust arrangement is key to the credit decision involving a living trust as collateral. If the proposed borrower is the beneficiary, an unfavorable credit decision is a likely result because the beneficiary has no control over the assets during the life of the trust or when the triggering event will occur. If the proposed borrower is the trustee, the creditor must ensure that the proposed credit transaction is consistent with the purpose of the trust. Regardless of the power of the trustee, a prudent creditor will ensure that taking the trust as collateral does not violate the purpose. Lastly, if the proposed borrower is a grantor who still retains power over the disposition of the assets in the trust, then the creditor is likely grant the loan as long as the credit agreement is not in violation of the purpose of the trust and the terms and conditions regarding the assets held in the trust prevent the grantor from removing the assets and leaving the creditor with an empty trust as collateral.