Home Refinance Can Foul Up Estate Planning

MAY 19, 2014 VOLUME 21 NUMBER 18

When our clients consider creating a revocable living trust, we usually explain that there are several benefits to that estate planning device. Chief among those benefits for most people: avoidance of probate on the death of the client. For married couples, there is usually no probate required on the first death anyway, so a living trust mostly protects against having a probate on the second death.

A few of our clients also see other benefits from living trusts. They may make it easier to minimize estate taxes on the death of the second spouse (though, frankly, current estate tax rules for Arizona residents make this a benefit for a very, very small portion of the population). They may make it easier to control the use of funds for heirs — though many clients are uninterested in imposing any restrictions on the inheritances they leave to children or others.

The living trust may have benefits beyond probate avoidance for a small number of our clients, based on their family situation, type of assets or the size of their estate. But for every client who decides on a living trust, the same two drawbacks need to be weighed against the benefits in their circumstances. First, a living trust is a more expensive estate planning option (how much more expensive? That will depend on individual circumstances, but typically between $1,000 and $2,000 more for most of our clients). Second, and the subject of this week’s cautionary story, is this: if you have a living trust, you need to keep that in mind for the rest of your life, and make sure that your assets get transferred to, and remain titled to, your living trust.

We were reminded of this issue by a typical client story we heard last month. A couple who have been long-time clients — we’ll call them Dick and Jane — created their joint revocable living trust a few years ago. They did it for the usual reason (to avoid probate on the second death), but also for a less-common reason — Dick had been diagnosed with early dementia, and the trust would make it easier for Jane to manage their joint assets as his capacity began to diminish.

After they created their trust, that’s exactly what happened. Dick became less and less able to make decisions, and more and more reliant on assistance with activities of daily living. In fact, Jane found that she had to hire help to take care of Dick in their home. Fortunately, she had a durable power of attorney and the living trust in place — she was able to take care of their finances and marshal them for Dick’s care needs.

Jane figured out that it would make sense for them to refinance their home mortgage. That might have been true just because of the current historically low interest rates — in Dick and Jane’s case, it also made sense to take out some additional principal from their home equity, so that Jane would have sufficient reserve to cover Dick’s growing care costs. It was a good thing that their home had been transferred to their joint trust, since Dick had lost the ability to sign refinancing documents. Because she was the sole trustee, Jane would be able to handle the refinancing by herself.

You might know where this story is going next. If Jane had called us, we could have warned her about the problem that was likely to arise. We don’t expect our clients to call us before making major financial decisions, but in this case it would have been good to hear from Jane. Why? Because the title insurance company insisted that Dick and Jane’s home had to be transferred out of the trust before the refinancing could be completed. And (possibly because the title company was based in Kansas, not Arizona) there was another problem in the documents: the title company’s attempt to create a joint tenancy between Dick and Jane did not comply with Arizona’s requirements. That meant that when Dick died a year later, his one-half interest in the family home had to go through the probate process.

To be clear, that result was not nearly as tragic as Dick’s medical and mental decline and ultimate death. In the scheme of things, the need for a probate proceeding — especially in a state, like Arizona, where probate is a relatively simple process — is more properly characterized as “nuisance” than “tragedy”. But the irony of Dick and Jane’s experience was that they intended to simplify things, and to save money for their heirs — and, despite their best efforts, the result was that Jane actually had to go through extra legal proceedings (since their home was originally in joint tenancy, there would not have been a probate on Dick’s death but for the refinancing following the trust). To be sure, if they had not created the trust and signed powers of attorney, Jane probably could not have refinanced the home at all without a court proceeding to establish authority over Dick’s share of the home, so the net effect was probably beneficial. But the disconnect between the estate plan and the title company’s odd insistence on taking the home out of the trust meant that Dick and Jane missed an opportunity to have their plan work perfectly.

Why do title companies insist on taking homes out of trust for refinancing? This has always puzzled us, too. Apparently, they think that the record is unclear about whether the trustees of a trust have the right to encumber the home with a mortgage — but they are not at all troubled about the trustees’ right to transfer the house outright. Why don’t the title companies then transfer the home back into trust? This one puzzles us, too. Until a decade or so ago, they would do so upon request. Now they typically fail to mention it to their clients at all. And why would a Kansas title company try to practice law in Arizona, creating a defective joint tenancy deed? We have no answer for this one.

Here’s the moral of the Dick and Jane story (or at least this tiny slice of their story — their real story is far, far richer than this one small glitch): if you have established a revocable living trust, be very cautious about titles to your property. Your home, your bank and brokerage accounts, and most of your other assets should probably be titled to the trust (talk to your lawyer — this is not always the case). Once things are titled to the trust, you have to be mindful of any changes you might precipitate, even (especially?) if you did not intend to make any change.