When a family member or close friend passes away and names you as an heir in their will, you may be one of several heirs. Often multiple heirs divide the inheritance. Resulting in an important decision. Sell the property, share ownership, or one heir buys out the others. So, a popular question is how to refinance an inherited property to buy out heirs. Buying out the other heirs is possible no matter if there is an existing mortgage or free and clear. Plus, there is even the chance of refinancing an inherited property with cash out. Therefore, it is key to understand how Fannie Mae and FHA treat inherited property.
Decision to Buy Out Heirs
An inherited property is an asset that has a market value and usually a sentimental value too. Some heirs may own a house already, live too far away, or just don’t want to own a property. Typically, these heirs choose to sell the home or to be bought out by another heir. If one of the heirs chooses to purchase the property, the following usually happens…
- Verify the inheritance percentage through the will
- Determine the property value
- Decide on an acceptable price
Next, the heir who is buying out the remaining heirs must pay cash or obtain a mortgage. If choosing the mortgage route, there are certain requirements and benefits. Although it is stated as a purchase, Fannie Mae and FHA loans treat it as a refinance. The reason is that the heir is already an owner with an equity stake in the property. Therefore, the borrower refinancing the inherited property to buy out the heirs has equity in the property. This equity is this heir’s portion of the value per the will. For instance, if the property is worth $210,000 and there are 3 heirs, the borrower has $70,000 in equity.
Fannie Mae Guidelines Buying Out Heirs of Inherited Property
If a Fannie Mae conventional loan is being used to buy out the heirs of an inherited property, it is treated as a refinance. Because this is a refinance and the heir may use their equity as down payment, there is usually no cash to close. Additionally, the loan to value is not determined by the price paid to the other heirs.
Actually, Fannie Mae loans uses the appraised value. This is beneficial because the value typically exceeds the inherited property purchase price. Since the loan amount is a lower percentage of the appraised value, there are benefits. Such benefits including better interest rate, easier to qualify, and potentially avoiding private mortgage insurance (PMI).
What if you are not going to occupy the inherited property? Actually, Fannie Mae loans allow you to buy out an heir plus finance the home as a second home or rental property!
FHA Inherited Property Guidelines
Like Fannie Mae loans, FHA treats buying out heirs of inherited property as a refinance. Also the appraised value rather than the price paid to heirs is used to determine the LTV. Just like a traditional purchase or refinance, there are times where FHA has advantages over a Fannie Mae loan. Choosing an FHA loan to buy out heirs of an inherited property include the following:
- More flexible credit requirements
- Easier approval with less equity
- Potentially higher debt to income ratio
Usually the main disadvantage of an FHA vs Fannie loan is that the PMI must stay on the loan at least 11 years for a 30 year term loan. If over 90% of the appraised value, it must continue for the entire term. Even loans under 80% of the value require PMI. When under 80%, a conventional loan should be used unless FHA is the only approval available.
Buying Out Heirs and Including Closing Costs
Buying out the heirs so you can obtain the house sounds great. But, are you worried about coming up with the closing costs, first year of homeowners insurance, and escrow setup? No worries…as long as there is sufficient equity in the home! With enough equity in the property, all costs may be included in the loan. The result is buying a property with no cash to close! Although if there is more equity, can you get some cash out? Maybe!
How to Cash Out Refinance an Inherited Property
Since both Fannie Mae and FHA loans treat buying out heirs as a refinance, it is possible to receive cash back. In order to receive cash after paying off heirs, there must be enough equity in the property. Remember we are using the appraised value. So, when the price paid to other heirs is a lower percentage of the value, receiving cash back is possible.
Documentation Requirements for Inherited Property Buy Out
No matter which mortgage type is used, there are certain required documents. First, the borrower must prove the property inheritance through providing the will. If there is an existing mortgage on the property, a payoff must be obtained. In order to determine the heir payoffs, the purchase agreement among the heirs must be provided. Although this does not have to be full residential purchase agreement. Finally, the borrower needs to provide documentation required by the preapproval. These include proof of income, assets, and credit.
If receiving cash out from refinancing an heired property, the borrower must provide a cash out explanation letter. Basically, it states the reason for receiving cash in hand at closing.
Property related items include an appraisal, title search, and insurance. The lender orders the appraisal and title search. Then, the borrower(s) choose any required insurance (homeowners, flood, wind & hail).
Whether you are the estate attorney or someone else involved in the inherited property, we hope this provides your desired knowledge on the subject. If you have questions, ask us!