Security for Parents helping Kids from Defaulting on Mortgage on New Home

A Colleague's question:

Hey David,

Can I run something by you? I have a client who wants to help his daughter and son-in-law out of a potential default on a mortgage. He wants to make the mortgage payments for them until they sell the house and then get paid back for the amount that he put toward the mortgage from the sale proceeds. So I was thinking a promissory note would work for that....he doesn't want to do a private mortgage on the property. But the Dad also wants to have control over the selling of the house, pricing, etc and wants a Power of Attorney drafted to deal with that. I told him that the Power of Attorney if the kids signed it could give him the ability to negotiate on their behalf and sign all the documents, but if the kids are here, they can just as well sign the transfer documents and sale proceeds would still have to go to the kids. So I'm not sure that's the best option but I can't really think of what else to suggest to him...would a specific PA work if I drafted it to say that the father has the power to negotiate sale price and deal with all aspects of the sale of the house and then have the promissory note say that the mortgage funds owing back to the Dad would be repaid from the sale proceeds when the house sold?

Thanks!
CONFIDENTIAL

My response:

Hi CONFIDENTIAL,

I can imagine that over the next year we will see more of this type of scenario. As the economy slows and unemployment grows, while real estate values drop; there may be negative equity situations. People are going to be forced with some decisions about whether they want to try to hang on and maintain their credit ratings; or if walk away and let the bank foreclose. I think its better to hang on as values will come back.

In this specific scenario; the Father wants to help his daughter and son-in-law keep their house. The Father will make the mortgage payments, keep track of such, and then be repaid upon the ultimate sale of the house.

Your first idea, of a private second mortgage to secure this account is the best option. The new mortgage encumbers the property but if there is not sufficient equity in the property. On a sale, there may be nothing left after the first mortgage is paid out. While a Power of Attorney will allow the Father to sign documents regarding the transaction, the person acting as Attorney must be acting in the donor’s best interests (fiduciary relationship) so I think it creates a conflict of interest to give the Father conduct of a sale by Power of Attorney. He clearly has his own interests he has to worry about which may not be the same as the owner.

The Father must consider how much equity is in the property if he wants to encumber it to try to protect his loan account.

There is a risk is that if the property decreases in value, the Bank may foreclose and he would not be repaid from the proceeds of the sale. Keep in mind that there may be a significant prepayment penalty of interest.

I think you could do the Power of Attorney and promissory note, but I don’t think you can represent both the Father and the Kids.

What is the time frame they are considering? If they are selling right away, the Father could be present and help the Kids get a realtor, but it would be a lot neater if they signed everything.

There should be arrangements for the Daughter and Son-in-Law to repay the loan, other than just waiting for a sale. They may repay the Father in full in due course and keep the property.

If they want to keep the property, a significantly different option is for your client to keep records of this loan account and to reference it is his Will. The loan account would remain outstanding until repaid; or it could be considered an advance on an ultimate estate distribution.

I hope this helps.

Best regards,

David