Losing a loved one is never easy, but receiving an inheritance can provide some financial relief during such a difficult time. However, before rushing to cash in that inheritance check, it’s important to carefully consider all your options. One option some explore is taking out an inheritance loan, also known as an ancestral estate loan. While an inheritance loan may seem like a quick source of cash, there are important factors to weigh first.
What is an Inheritance Loan?
Definition of key terms
An inheritance loan is a type of asset-based loan where the expected inheritance serves as collateral. More specifically:
- Collateral: The asset being used as security against the loan in case of default. In an inheritance loan, the expected inheritance acts as collateral.
- Lender: The entity providing the loan funds, usually a bank or specialty lender.
- Borrower: The individual receiving the inheritance who takes out the loan against their expected funds.
- Inheritance: The financial assets being passed down, such as cash, property, and investments. These serve as collateral for the loan.
- Loan Amount: The sum of money provided to the borrower upfront based on the appraised value of the expected inheritance serving as collateral.
So, in summary, an inheritance loan allows a person expecting an inheritance to borrow money against future assets before formally receiving them. The inheritance itself acts as collateral to secure the loan.
How Inheritance Loans Work
A step-by-step overview of the process:
Apply for the Loan: The prospective borrower applies for the loan with documentation of their expected inheritance, such as a will, trust documents, or letters of administration.
Assess Collateral: The lender evaluates the nature and appraised value of the expected inheritance listed in the documentation to determine how much can be borrowed against it.
Approve the Loan: If approved, the lender agrees to provide a loan for a percentage (usually 60-80%) of the appraised inheritance value.
Receive Funds: The borrower receives the loan amount upfront in a lump sum payment or installments.
Make Payments: The borrower makes regular interest-only or full payments to the lender on an established repayment schedule, usually 6-36 months.
Inheritance Received: Upon formal receipt of the inheritance, it goes towards paying off the outstanding loan balance. Any excess funds above the loan amount go to the borrower.
Loan Paid Off: If the inheritance fully covers the loan balance, the process ends there. Otherwise, the borrower is responsible for paying any remaining amount.
This allows borrowers access to cash from their expected inheritance in advance rather than having to wait until the estate is settled. Of course, there are risks as well, which I’ll explore next.
Potential Pros of Inheritance Loans
Access to funds sooner
For those in urgent need of money before an inheritance is settled, taking out a loan can provide welcome financial relief. Some potential pros include:
- Immediate Access to Capital: Borrowers receive loan funds upfront rather than having to wait months or years for the estate to close. This can help cover critical needs.
- Avoid Selling Assets: Rather than liquidating investments prematurely, a loan allows keeping assets intact to benefit from future growth.
- Utilize Collateral Value: The inheritance acts as valuable collateral to qualify for a larger loan at typically lower interest rates than personal loans.
- Preserve Inheritance: By using the inheritance as collateral rather than cashing it in, the full value is preserved to pay off the loan.
For the right borrower in the right situation, an inheritance loan can be a preferable alternative to draining savings or taking on high-interest debt. The immediate access to capital is a notable potential advantage.
Potential Cons of Inheritance Loans
Risks to consider
While inheritance loans may provide welcome funds, there are also drawbacks and risks to seriously weigh:
- Interest Costs: Even with a lower rate than personal loans, long-term interest costs can eat into inheritance funds if the loan isn’t paid off quickly.
- Inflated Loan Amounts: Unscrupulous lenders may inflate appraisals to approve larger, riskier loans. Borrowers end up on the hook for more than the inheritance is worth.
- Delays in Inheritance: If estate settlement is delayed, borrowers may struggle to make payments on time without the inheritance to offset costs. Late fees can accrue.
- Incomplete Inheritance: What if only a portion of the expected inheritance materializes, or other heirs contest the will? Borrowers are still responsible for the full loan.
- Eroded Collateral: Remaining loan-free allows inheriting assets intact rather than paying interest and fees that diminish the final payout.
- Strain on Heirs: Taking a loan against an estate can cause friction with other beneficiaries who may see it as encumbering or depleting shared resources prematurely.
So, inheritance loans are extremely high risk if the inheritance faces uncertainties or delays. Borrowers shoulder full responsibility for repaying the loan regardless of what transpires with the estate.
When an Inheritance Loan May—and May Not—Be a Good Idea
Guidelines to help decide
While inheritance loans provide access to funds quickly, they are definitely not suitable for every situation. Some general signs it may or may not be a wise choice:
May Be a Good Idea:
- Clear, Uncontested Will: If all heirs agree on the terms and there’s little ambiguity around what assets will be received.
- Imminent Settlement: If the estate is fairly straightforward and settlement is estimated within 6-12 months at most.
- Limited Needs: If the loan covers a timely, specific need rather than long-term or multiple debts.
- Portion as Collateral: Using just a predictable percentage rather than the full expected amount can lower risk.
May Not Be a Good Idea:
- Contested Will: If the terms are legally disputed by heirs, the settlement could take years with an uncertain outcome.
- Complex Estate: If multiple assets, ownership disputes, or tax implications complicate the process.
- Long Settlement: More than 1-2 years to finalize and distribute the estate greatly increases payment risks.
- Multiple or Large Debts: Inheritance loans intended to consolidate many obligations or cover an extensive period are very high-risk.
- Guaranteed Jobs/Income: Without reliable employment or assets, it may be difficult to qualify for or sustain loan payments if issues arise.
So, in summary – inheritance loans demand a high degree of certainty for the lowest risk. Ambiguous or complicated estates are not advisable candidates.
Alternatives to Consider Instead
Other options to explore
Given the risks inherent in inheritance loans, it’s important to thoroughly evaluate any viable alternatives as well:
- Personal Loans: For shorter-term needs, personal loans have fixed rates and repayment terms without betting on an uncertain inheritance collateral.
- Home Equity Line of Credit: For homeowners expecting inheritances, a HELOC taps home equity for lower interest than credit cards and can be paid off once funds are received.
- Downsize Expenses: Sell unnecessary assets, pause debt payments by contacting lenders, and reduce living costs to lower overall needs until the inheritance comes through.
- Crowdfunding/Grants: For essential costs like medical bills, consider online campaigns or grants for needs-based assistance through relevant organizations.
- Conservatorship: In case of lengthy delays, petition the court to release limited inheritance funds ahead to specifically pay living costs as a secured loan.
- Life Insurance Payout: For deaths with insurance benefits available, a policy payout can help address immediate costs without jeopardizing the larger inheritance.
Carefully weighing all options, including alternatives to inheritance loans, can help you determine the most prudent financial path to take over until estate settlement is complete.
How to Evaluate Inheritance Loan Offers
Tips for comparing proposals
If you do decide an inheritance loan makes sense for your needs, it’s critical to meticulously vet any offers. Here are key factors to examine closely:
- Interest Rate: Inspect the APR as well as whether rates are fixed or variable. Lower fixed rates are ideal.
- Terms & Repayment: Clarify the full payment schedule, term length, and prepayment penalties if paying off early versus late.
- Fees: Inquire about all associated costs like origination, late, or prepayment penalties that drive up total costs.
- Disclosures: Ensure all material terms are clearly explained upfront, with no surprises buried in the fine print.
- Lender Reputation: Check reviews, ratings, and licensing to verify legitimacy and avoid predatory operations.
- Application Process: Evaluate paperwork demands and timeline from initial contact to funding. Beware of lenders requesting excessive documentation or stalling payouts.
With any offer, don’t hesitate to negotiate terms to your advantage if possible. Only proceed with lenders who are fully transparent, have competitive rates and fees, and make you comfortable with all details. Trust your instincts and walk away from pressure tactics.
FAQs about Inheritance Loans
1. How much can I typically borrow against an expected inheritance?
Most lenders will loan between 60-80% of the appraised value of the inheritance listed in estate documentation. The exact amount may vary based on your individual circumstances and risk factors in the estate.
2. How long do I have to repay the loan?
Standard terms range from 6 months to 3 years, with many offering 1-2 year repayment periods. Ensure you understand the full schedule and can confidently afford scheduled payments.
3. What happens if the inheritance is delayed or falls short of expectations?
You are still legally responsible for repaying the full loan amount regardless of inheritance issues. Be cautious about taking a loan if there are significant risks the estate may underdeliver or take over 12 months to settle.
4. Can a co-signer improve my chances of approval?
Yes, having a co-signer with strong credit can boost your application since they share responsibility if you default. However, this also obligates the co-signer, so consider the implications carefully before adding anyone else.
5. Is the loan taxable as income when received?
No, inheritance loans are not considered taxable income since you must repay the amount borrowed. Only the funds received above what’s needed to pay off the loan would potentially be taxable as part of the estate distribution.