Inheriting a Home With an Upside-Down Mortgage

Inherited real estate can come as either a blessing or a curse depending on how many strings are attached. If the inherited property still carries a mortgage, someone must continue paying that mortgage until the home is paid off or sold. If your inherit a house whose mortgage exceeds its value, the house is “upside down.” You can't sell an upside down home for enough money to cover the mortgage debt. Fortunately, beneficiaries in this situation have options to avoid throwing good money at a bad debt.

Just because a home's mortgage is upside down that doesn't make the house worthless. If you can afford the payments and want to keep the house, you can do so. Federal law prohibits the lender from changing the terms of the loan when the homeowner dies and the property changes hands. Thus, you don't have to qualify for a new loan should you decide to keep the house.

If you inherit other assets from the estate, you may use those funds to either pay off the mortgage in its entirety or pay down enough of the loan to pull it out of its upside down status. Once the home is no longer upside down, you can refinance the loan into your own name if you wish.

You aren't legally obligated to accept assets you inherit. If you inherit a home with a mortgage you cannot or will not pay, you can simply walk away and let the bank foreclose on the home. Legally, you're not on the hook for the mortgage payment, and your credit will remain unaffected.

A problem arises, however, when the bank sells the foreclosed home. If the property sells for less than the former owner owed on his mortgage – and this is likely with an upside down home – the lender is entitled to collect the balance from the deceased's estate. This may reduce any further inheritance you and your family members receive.

Some individuals aren't comfortable abandoning a loved one's home to foreclosure. If you can't afford the payments but still wish to avoid foreclosure, consider negotiating a short sale with the lender. In a short sale, the lender permits you to sell the home for fair market value, even if fair market value is less than the mortgage balance. Like foreclosure, a short sale can leave behind a deficiency. If the lender doesn't provide you with a written agreement not to pursue any leftover debt, it reserves the right to file a claim against your loved one's estate for the unpaid loan balance. Like foreclosure, the short sale of an inherited property does not hurt your credit because the loan is not in your name.

A deed in lieu of foreclosure is yet another option you have to deal with an inherited upside down mortgage. Through this type of transaction, you sign over the title to the home and the bank accepts the title as payment in full. Not all lenders will accept a deed in lieu of foreclosure for an upside down home. Those that do may require that you direct other assets from the estate to pay down the mortgage before turning over the property. While this may seem costly, banks do not pursue deficiencies after deed in lieu of foreclosure transactions are complete. Depending on how much your deceased loved one owed, negotiating a deed in lieu of foreclosure may be cheaper than trying to deal with a deficiency lawsuit after a foreclosure or short sale.