Loans from a trust can be a great financial tool but they can be complicated and tricky!getty
So, you have an irrevocable trust (or several) and you want to take a loan from the trust. While that might sound simple it really may not be as simple and you think, and you should discuss the decision with your trust attorney, CPA, and the trustee (especially if it’s a professional or institutional trustee with expertise in how this might be done) before you pull the loan trigger. Listed below are some of the many points you might want to consider before you have an irrevocable trust make a loan.
An irrevocable trust can be a great tool for protecting assets and planning for the future. But what happens when the trust needs access to cash? Can an irrevocable trust get a loan?
The short answer is yes with some caveats. While an irrevocable trust cannot personally guarantee a loan the trust can use its assets – especially real estate – as collateral for a loan. However, getting financing from a traditional lender can be challenging. Understanding how irrevocable trust loans work is key.
What is an Irrevocable Trust?
First a quick primer on irrevocable trusts. An irrevocable trust is a trust that cannot be changed or revoked once it has been set up. The grantor gives up ownership and control of any assets placed into the trust.
Irrevocable trusts are commonly used for estate planning purposes to avoid probate and minimize estate taxes. They can also protect assets from creditors and lawsuits.
Once assets are transferred to an irrevocable trust, they belong to the trust The grantor no longer controls or owns the assets.
Can an Irrevocable Trust Borrow Money?
An irrevocable trust itself cannot personally guarantee repayment of a loan. However, the trust can use its assets – especially real estate – as collateral to secure financing. Lenders can place a lien or mortgage on trust property in exchange for a loan to the trust.
If the irrevocable trust has significant real estate equity, the trust can most likely qualify for a loan. The loan proceeds would go directly to the irrevocable trust to use for its benefit.
Common reasons an irrevocable trust may need to borrow money include:
- Paying expenses and bills of the trust
- Funding repairs or improvements to trust property
- Equalizing distributions to beneficiaries
- Buying out other trust beneficiaries
- Avoiding property tax reassessments
As long as the loan is repaid, using trust assets to secure financing is usually acceptable. The trust document should be reviewed to ensure there are no restrictions against borrowing.
Challenges of Irrevocable Trust Loans
While irrevocable trusts can legally borrow money, getting a loan as a trust can be challenging compared to individual financing.
Traditional lenders like banks often will not lend to irrevocable trusts. Some key complications include:
No Personal Guarantee – Since the trust can’t personally guarantee repayment, more scrutiny is placed on the trust assets used as collateral.
No Credit Score – Irrevocable trusts do not have a credit history or credit score. This makes underwriting more difficult.
Short Loan Term – Loans to trusts typically have shorter 3-5 year maturity dates. Long 30 year loans are rare.
Balloon Payment – Most trust loans require a balloon payment of the entire balance at maturity.
Higher Interest Rates – Due to the risks and challenges of lending to a trust, interest rates are often higher.
Limited Financing Options – Only a handful of specialized lenders will originate irrevocable trust loans.
These financing challenges mean irrevocable trusts interested in borrowing need to find alternative lending sources.
Irrevocable Trust Loan Lenders
While traditional banks shy away from irrevocable trust loans, there are specialized lenders who can provide trust financing. These lenders include:
Private Lenders – Also known as hard money lenders, private lenders offer irrevocable trust loans using funds from private investors. These loans charge higher interest rates but can close quickly.
Mortgage Brokers – Experienced mortgage brokers have access to niche trust lending programs that traditional banks don’t offer.
Family Offices/Foundations – Wealthy families sometimes act as private lenders and may finance trusts they are affiliated with.
Attorneys – Estate planning attorneys occasionally lend money to irrevocable trust clients when needed.
In addition to higher costs, trust loans from these alternative sources often have shorter 1-5 year loan terms. The trust will need to refinance into a conventional loan once assets are distributed from the trust.
Refinancing an Irrevocable Trust Loan
Refinancing an irrevocable trust loan involves a few extra steps compared to a typical refinance. Here are some key points:
- The new loan must also be originated to the irrevocable trust.
- Only certain lenders will allow irrevocable trust loan refinancing.
- The trust assets used as collateral should have increased in equity.
- Loan terms likely will still be shorter than traditional refinance loans.
- Once trust assets are distributed, beneficiaries can refinance in their personal names.
Using a Trust as Collateral for a Loan
When assets are owned by an irrevocable trust, using those trust assets as collateral is the most common way for a trust to obtain financing. Some key considerations around using trust assets to secure a loan include:
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Real estate equity – If the trust owns real estate, this can be used as collateral for a mortgage loan. There must be sufficient equity in the property to qualify.
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Note and deed – The loan will require supporting documentation like a secured promissory note and recorded deed of trust.
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Trustee approval – The trustee(s) must approve using trust assets as collateral and sign loan documents.
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Trust distribution – Beneficiaries receiving distributed assets may need to sign acknowledgement of loan terms.
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No personal guarantee – Trustee(s) should not personally guarantee the loan which would negate trust protections.
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Asset ownership – Assets used as collateral must be owned by the trust with no ownership disputes.
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Trust provisions – The trust document should be reviewed to confirm ability to borrow against assets.
As long as the proper steps are taken, almost any valuable asset owned by an irrevocable trust can potentially be used as loan collateral to benefit the trust and its beneficiaries.
Why Banks Won’t Lend to an Irrevocable Trust
Given the challenges, why are traditional banks so reluctant to provide irrevocable trust loans? Here are some of the top reasons:
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Risk management – The lack of recourse from a personal guarantee is riskier for banks.
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Credit policy – Strict lending policies may prohibit trust loans outright.
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Loan resale – Loans to irrevocable trusts don’t conform to secondary market standards.
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Loan servicing – Servicers aren’t equipped to handle loans without individual borrowers.
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Relationship focus – Banks prefer to make loans to established individual customers.
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Profit motivation – More work for less reward means banks have little incentive.
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Assumption of risk – Easier for banks to just avoid potential issues with trust loans.
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Knowledge gap – Many bankers don’t understand irrevocable trust loan dynamics.
Essentially, financing irrevocable trusts is outside the comfort zone of traditional banks. The perceived risks and operational challenges outweigh any potential rewards.
Alternatives to Borrowing Against a Trust
Before exploring financing options, trustees and beneficiaries should review whether borrowing is the right solution or if there may be better options available:
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Request a distribution – Distributions may avoid trust taxation or other consequences of a loan.
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Have the trust make purchase – A trust can buy certain assets like real estate directly instead of loaning cash.
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Use personal funds – Beneficiaries can opt to pay personally from outside the trust.
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Sell assets – Liquidating assets like investments or real estate may generate needed cash.
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Wait – Certain needs like paying estate taxes may be resolved over time.
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Seek co-ownership – Adding a beneficiary as co-owner of an asset may circumvent need for formal loan.
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Contribute collateral – Beneficiaries can contribute personal assets as additional collateral.
All alternatives should be explored before pursuing trust loans which can have high costs and complications. Consulting experienced advisors is key.
The Bottom Line
While possible, getting financing through an irrevocable trust is much more difficult than individual or conventional loans. Trustees and beneficiaries need to consider specialized irrevocable trust lenders offering asset-collateralized financing options.
The intricacies of irrevocable trust loans mean working with knowledgeable advisors like estate attorneys, CPAs, and tax professionals is a must before moving forward. With proper guidance and planning, an irrevocable trust can successfully obtain needed financing in many situations.
Create an Annotated Trust
If you are not an expert at reading trust documents (most non-estate and trust lawyers aren’t) here’s a tip. If you’ve never annotated the trust document to create a roadmap for trust administration considering doing that. Work with the attorney who wrote the document, or who currently represents the trustee.
In the “old days” that would entail getting a signed copy of the trust and a yellow highlighter (if you don’t know what that is ask one of your grandparents). Then review the trust with the attorney and highlight the key provisions. The first step for some trusts is to go through the trust and add English captions. Some lawyers still identify provisions in the trust by article (e.g., “Article 3” instead of saying “Distribution Provisions”). Not having names for each section just obfuscates what they are and makes it really hard for anyone (even the lawyers who write trusts that way) to read the trust document. So, if you have to, write in captions on each trust provision to accompany the article designations. Next, when that is done identify key provisions the attorney tells you that you must understand to administer and operate the trust. This is often very different then the focus that you (or whoever set up the trust) had when the trust was created. This will include a lot of the provisions that when the trust was created were dismissed as routine or “boilerplate.” These supposedly standard (they really aren’t which is why you should go through this exercise) provisions may have been glossed over when the trust was planned, but they are essential to how the trust is administered. So, even if you just set up the trust and feel you don’t need to go back to the attorney just yet, yep you do. Next, again using our old-style paradigm, you should write margin notes on the trust document both explaining the provisions and with recommendations as to how you implement them. For example, notate when certain actions are completed that they can be done by the trustee alone. Identify common other situations when the trustee might need the approval of the trust protector or other person, or when the trustee should speak to the trust CPA or attorney before making a move. Some actions might best be documented by the trustee formally, others might not require that. Make the annotations both understandable, practical and informative. That will put “meat” on the trust “bones” so that lay persons have a better idea what to do to operate the trust properly.
Here’s the more modern approach to the above exercise. Get an electronic version of the final signed trust and convert that PDF to Word or whatever word processing software you use. Highlight the trust as above. Try using three different colors, e.g., blue for captions, yellow for trust provisions and green for your annotations. Consistency in color coding will make using this new electronic trust roadmap easier. MORE FROM
The annotated version of the trust should then be updated whenever you ask one of the trust’s professional advisers a question so that it evolves as you administer the trust. This can be effective to save professional fees as you won’t have to ask the same questions repeatedly. But its most important benefit is to help those involved with the trust know when to seek professional help. Remember, fixing a mess after the trustee does something wrong is always going to be much more costly then having an adviser tell you what to do right before you do it wrong and gum up the trust.
In addition to highlighting and explaining key provisions make some notes on top of the trust with some key information so it is available whenever you look at the trust. This info might include the trust tax identification number as you will need that for many types of transactions. Perhaps listing all the key persons and their phone numbers and email addresses. This would include not only the trustee but other fiduciaries (modern trusts might have five or more such roles) and even other key positions (e.g., powerholders, trust protector, etc.). You should also note the tax character of the trust as grantor, non-grantor, QSST, etc. Your CPA can explain these points to you. You should notate that the tax status of the trust can change so you don’t just assume that notation is good forever. This will all be relevant to what you thought was a simple decision on taking a loan from your trust, as will be explained below.
Should You Consider a Trust Distribution Instead of a Loan?
Before you charge forward with having a loan made under the terms of the trust evaluate options, ideally with the trust’s professional advisers as this could be a significant decision. Consider whether you really want to take a loan from the trust and why? Before you make a decision consider all the options that may be available. You might request that the trustee make a distribution. Depending on how the trust is structured that might have good or bad income tax consequences. For example, if the trust is a grantor trust (taxed to the person who set it up) making a distribution will likely have no income tax consequences. If instead the trust is a non-grantor or “complex” trust, making a distribution might flow income out of the trust to the recipient/beneficiary. That might be good or bad and you should probably ask the trust CPA to advise you as to the consequences before doing so, it could be complicated. You have to consider the tax rate the trust pays on income, the tax rate the beneficiary would pay if he or she received a distribution that was income, whether the distribution will in fact draw out income to the beneficiary (e.g., depending on the trust terms if the income was a capital gain the trust may have to pay the tax), etc. If the new trust income tax surcharges being proposed in Washington are enacted, that could change the decision process. Also, consideration should be given to the status of the beneficiary. If the beneficiary is in the midst of being sued or getting a divorce, making a distribution is not likely to be a smart move.
Should The Trust Buy An Asset Instead of Making a Distribution or Loan?
Let’s use a really common example to illustrate this loan alternative. A kid is a beneficiary of a trust and wants to buy a new home. The knee-jerk reaction of many is to have the trust make a distribution to the kid so the kid has the money to purchase the home. But that means that the kid will own the home and the money is removed from the protection the trust would have afforded (from divorce, lawsuits, estate taxes, and more). That is not always a wise move, but frequently done. If instead of giving the money to the Kid to buy a house, the trust could loan the kid the money to buy the house. Since the kid is a beneficiary, the trust might not even need to charge interest. But that is complicated too, especially if there are siblings who are beneficiaries and who are not receiving identical loans. A loan to the kid might be a better option than a distribution as the kid will owe the money back to the trust so that the value of the loan remains an asset of the trust, protected from divorce, lawsuits and estate taxes. But there may be a third and better option to consider. Perhaps the trust could buy the house and let the kid use it. That way there is no asset in the kid’s name and the value of the property remains protected inside the trust. That might be the best result. The kid might initially object “Gee I want to own my own home.” But explain the benefits of trust ownership. Also point out that when the kid is sitting on the living room couch watching the Squid Game no one is going to know or care whose name is on the deed. There are more issues and details to a trust owning a home, but that will be for another article.
Non-Grantor Trusts Should Not Loan Money to the Settlor But May To Others
If the trust is a non-grantor trust (the trust pays its own income tax) the person who set up the trust probably should not take a loan. That’s because a loan, if it does not have adequate security or adequate interest, could change the tax characterization of the trust from a non-grantor trust to a grantor trust. That could undermine the intended tax benefits the trust was created for. Well, you’ll just make sure that there is adequate interest and security. That is probably not worth the risk as it is not always clear what those terms mean in the tax law.
What if someone other than the settlor who created the trust wants a loan? If you are going to make the loan to the spouse or minor child of the settlor, check with the trust attorney and CPA first. If to someone else, it may be fine from a tax perspective to make a loan. But before you do go back to square one above and see what the trust says about it. No matter the tax and economic consequences, any loan should comply with the terms of the trust agreement.
DON’T Use an Irrevocable Trust Without These 4 Things
FAQ
Will banks lend to an irrevocable trust?
How do I get money from an irrevocable trust?
Can I take a loan against my trust?
Can an irrevocable trust hold a mortgage?
Can I borrow money from an irrevocable trust?
Lending to an irrevocable trust is available but typically only from specialized irrevocable trust loan lenders. Irrevocable trust loans to beneficiaries and trustees allow for borrowing against trust-owned real estate. This is essentially a home equity loan against the real estate within an irrevocable trust.
What is an irrevocable trust mortgage?
Conventional lenders such as banks and credit unions cannot typically provide an irrevocable trust mortgage as the sibling’s name is not on the title of the property. An irrevocable trust loan lender is able to provide the loan directly to the trust with the loan proceeds going directly to the trust’s bank account.
Can I refinance an irrevocable trust mortgage?
If the property is going to be transferred out of the trust and into an individual’s name, an irrevocable trust loan lender will be able to help. Once the property transfers out of the trust, the individual can refinance the irrevocable trust mortgage with a long-term conventional loan.
How do revocable and irrevocable trust loans work?
This is the case for both revocable and irrevocable trusts. Irrevocable loans require approval from the trustee in order for the beneficiary to take a loan from the trust. A trust loan company will oversee the process with applications from both the beneficiary and trustee.