Using a Trust as Collateral for a Loan: A Guide to Navigating Trust Loans for Real Estate in Irrevocable Trusts

Using a trust as collateral for a loan can initially seem challenging when the real estate is held in an irrevocable trust. Traditional financing from banks or other large institutional lenders is typically not available to irrevocable trusts. Understanding how to use a trust as collateral for a loan can help trustees and beneficiaries obtain the needed financing. This article will explore trust loans for real estate in irrevocable trusts.

What is an Irrevocable Trust?

An irrevocable trust is a legal arrangement in which the grantor (the person who creates the trust) transfers ownership of assets into the trust, relinquishing control over them. Unlike revocable trusts, irrevocable trusts cannot be altered or terminated. Many trusts begin as a living trust or revocable trust but then automatically become irrevocable once the original trustees pass away. At this point, the successor trustees named in the trust document have the power to act on behalf of the trust. Using the trust as collateral for a loan to help administer the trust is a common action taken by successor trustees.

Trust Loans for Real Estate in Irrevocable Trusts

In an irrevocable trust, the new trustee may quickly find they cannot secure traditional financing from banks and other financial institutions. These types of lenders do not lend against assets in an irrevocable trust. Specialized trust loan lenders are able to provide short-term financing using the trust-owned real estate as collateral.

Using a Trust as Collateral for a Loan

Using a trust as collateral for a loan involves leveraging the real estate assets within the trust to secure financing. Here’s how it works:

1. Loan Application: The trustee applies for a loan with a lender that specializes in trust loans. The application process will involve a review of the trust documents, the value of the real estate, the exit strategy for the short-term trust loan and the terms of the trust.
2. Collateral Evaluation: The lender determines the value of the real estate within the trust. Unlike traditional loans, the main emphasis is on the value of the trust’s real estate rather than the borrower’s income and creditworthiness.
3. Loan Disclosures and Documents: Once the loan is approved, loan disclosures and documents are prepared that detail the terms and conditions of the loan, including the interest rate, fees, and repayment schedule.
4. Securing the Loan: The real estate within the trust is used as collateral. If the trust defaults on the loan, the lender has the right to force the sale of the collateral to recover the loan amount. The same process is followed as with a traditional type of real estate loan.
5. Fund Disbursement: The loan funds are disbursed to the trust’s bank account. This provides the necessary liquidity for various financial needs of the trust, such as paying off debt, covering maintenance costs, making improvements to the property or buying out other siblings/beneficiaries.

Benefits of Using a Trust Property as Collateral

1. Preserves Trust Integrity: Using a trust loan allows trustees to access needed funds without first dissolving the trust or selling assets. This maintains the integrity of the trust until assets of the trust are distributed to the beneficiaries and the trust can be dissolved.
2. Flexibility and Access to Liquidity: Irrevocable trust loans provide financial flexibility, enabling trustees to address immediate financial needs, cover unexpected expenses, repairs or make improvements to the property or fund a sibling buyout loan.
3. Asset Protection: Since the loan is secured by the trust’s assets, there is no need for the trustee (or beneficiaries) to use personal assets to provide the trust with liquidity or use their personal assets as collateral for a loan.

Challenges and Considerations

1. Finding an Irrevocable Trust Loan Lender: Only specialized lenders offer irrevocable trust loans. It may be difficult to find a capable and experienced private lender providing this type of financing in the location of the trust-owned real estate.
2. Legal and Financial Advice: Obtaining the guidance of a trust attorney with experience in trust administrations is recommended to understand the implications of using a trust as collateral and to ensure compliance with the trust terms.
3. Loan Terms and Interest Rates: Trust loans typically have higher interest rates compared to traditional loans due to the specialized nature of the short-term loan. It’s important to carefully review and understand all costs and fees associated with the loan terms.

Conclusion

Securing a loan using a trust as collateral can be a strategic and quick path to providing the irrevocable trust with the needed liquidity. By understanding the process and utilizing specialized lenders, trustees can unlock the potential of trust assets without compromising the trust’s integrity. As with any financial decision, seeking professional advice and thoroughly evaluating options is required to ensure a beneficial outcome.

North Coast Financial is an experienced irrevocable trust loan lender for California real estate. Please contact us for a free consultation.

The information provided herein is for educational purposes only. North Coast Financial is not providing any legal, tax or financial advice.