The business of probate lending has exploded over the past decade or so, with dozens of new probate lenders emerging in the marketplace over that time. What is probate lending and why the aggressive expansion in recent years? Due to the continued aging of the baby boomers generation (i.e. 10,000 new boomers are reaching retirement age everyday), the number of people passing away is increasing each year. While many of those that pass have estate plans in place, a significant number do not. And with the increase of probate administrations and the length of time it takes to complete, many beneficiaries are looking to alternative resources to obtain funds in advance of the completion of a probate case. As a result, several lenders have begun to specialize in “estate advances” in order to fulfill this need.
An estate advance has become an extremely prevalent and controversial financial transaction in the probate and trust context. As the name suggests, an estate advance is where a lender “advances” funds to a beneficiary in exchange for an assigned interest in an estate.
To illustrate, lets say Henry just passed away without a trust and his estate (worth $600k) is going through probate. Matt is Henry’s grandson and is going to inherit one half of Henry’s estate (i.e. $300k). Instead of waiting for the estate to be administered though probate, which typically takes a year or longer, Matt accepts an offer from a probate lender to receive $216k in cash (payable now) in exchange for Matt’s interest in his grandfather’s estate (which will be distributed at some point in the future).
It is important to note that an estate advance is not a loan; it is technically an “assignment” of a beneficiary’s interest in an estate in exchange for a lump sum payment.
That being said, we wanted to take a few minutes and explain some of the pros and cons of estate advances, as well as give our insights on some of the nuances involved. Lastly, we want to impart our opinion on when estate advances should be considered by beneficiaries and/or endorsed by professionals representing beneficiaries and when other options should be considered.
As for the pros, there are two main advantages of estate advances to beneficiaries. The first one being that it allows a beneficiary to receive money sooner than he or she otherwise would. Most probates take between nine months to a year and half to complete (sometimes longer) and gaining possession of funds is always preferred due to the time value of money. The second major upside to estate advances is the fact that “assignments” are non-recourse, meaning a beneficiary takes on no personal liability from these types of transactions. This is unlike getting a “loan,” which typically requires assuming personal liability or at least pledging collateral to provide insurance for the lender in case repayment is not made.
While gaining early access to funds earmarked for distribution in a year’s time is advantageous, there are multiple disadvantages in “assigning” an inheritance interest for cash now. The first one being that it is very expensive for beneficiaries who engage in these transactions; meaning beneficiaries receive far less value than they otherwise would if they were to wait until distribution of the estate. Distribution of an estate is the final stage of a probate administration and, as we stated previously, most probates take about a year or so to complete. According to a recent survey done in a major county in California, the average annualized percentage return for probate lenders performing estate advances was just under 70%. That is a very deep discount to take as a beneficiary and a stellar return on investment from a probate lender’s perspective.
The second major downside to estate advances is the fact that probate lenders acquire “standing” in a probate administration, establishing their right to file petitions/claims on behalf of the estate. In other words, probate lenders step into a beneficiaries shoes and obtain the power to: petition to remove the personal representative, petition to be appointed personal representative, sue for breach of fiduciary duty, petition to force the personal representative to sell real property, or file for preliminary distribution. According to the survey alluded to above, nearly one third of the probate lenders, who were assigned interest in an estate, filed petitions or objections in the matters they were involved in. Such petitions and objections filed are always in the benefit of the specific probate lender and can be extremely cumbersome to deal with during an administration. Lenders are typically sophisticated parties and can make it extremely difficult for beneficiaries to control the administration process and the distribution of assets.
In addition to the basic pros and cons of estate advances, there are some other relevant details and nuances that should be considered.
Some critics argue that estate advancers are engaging in a form of “consumer exploitation” by offering beneficiaries small cash payments relative to the size of their inheritance. These same critics point to a lack of regulatory protections for beneficiaries by claiming usury laws and truth-in-lending disclosure requirements should apply to estate advancement transactions in order to protect innocent and unsophisticated consumers. Currently there are no such protections in place.
Usury laws restrict the amount of interest that can be charged in certain types of loans while the Truth-In-Lending Act requires that lenders make specific disclosures to borrowers prior to signing any loan documents. The purpose here is to allow consumers to become educated on the loan details and terms offered by different lenders, thus allowing them to make a more educated decision before committing to a loan program.
Proponents of estate advancements counter these arguments by pointing out that they are acting within the confines of the law as usury statutes and truth-in-lending laws do not apply to estate advances because unlike loans, estate advances are non-recourse. They further their position by explaining if, for any reason, a beneficiary’s interest in the estate is reduced or eliminated, the probate lender has no option but to absorb the loss. The following is a non-comprehensive list of reasons an estate’s value can be reduced or eliminated: mismanagement or conversion of estate funds by the personal representative, unanticipated medical bills, litigation costs (e.g. will contests, property disputes, reimbursement claims), extraordinary fees, devaluation of assets, previously unknown will discovered, etc.
It is also important to point out there is a rule in the probate code that was drafted to specifically address unfair estate advancement agreements between a beneficiary and a probate lender. Section 11604.5 of the probate code requires probate lenders to file their assignment agreements with the probate court within thirty days after they are signed. The rule further allows judges to refuse to honor these transactions if they are “grossly unreasonable” at the time the transaction was executed. There is no guidance in the rule as to what constitutes “grossly unreasonable” and enforcement of this rule is extremely rare.
With all of that said, what should beneficiaries do? How should professionals advise their beneficiary clients in regards to estate advances? As we’ve previously explained, an estate advance is a very expensive option and should therefore only be considered in unique circumstances. For instance, if an estate is illiquid and facing an imminent need for cash, and no other funding options are available, then an estate advance is a viable option for a beneficiary. Unfortunately, in our experience, there are very few instances where all such circumstances exist.
Often times, if an estate is strapped for cash and is facing the threat of foreclosure of a property, there are typically informal extension options available in lieu of getting an estate advance to pay outstanding mortgage payments or taxes or both. Furthermore, in some cases, an estate could request a preliminary distribution to settle any immediate debts or provide for the current needs of a beneficiary. It should be noted that a probate lender would likely try to pursue this option whenever possible since it will expedite their payoff period.
When contemplating an estate advance, it is important to emphasize that just about any loan product available on the market is likely going to be less expensive to a beneficiary than moving forward with an estate advance. The only instances where an estate advance could be viable are when the estate takes several years (2 or more) to administer. This is because the “effective interest rate” gets smaller and more reasonable to the beneficiary as more time elapses from payout to final distribution. The issue here is that it is typically very difficult to predict how long a probate administration will take to complete as a fair amount of them involve protracted litigation involving will contest, partnership dissolutions, breach of fiduciary duty claims by the personal representative, etc. And if a probate lender reviews the probate and sees the possibility of such litigation or the insolvency of the estate, they will likely either not engage in a estate advance or their offer will reflect the risk presented (e.g. offer less payment relative to the inheritance amount).
If you are a beneficiary, please consult your probate/trust attorney, CPA, professional fiduciary, or financial planner before entering into an estate advance transaction.
The CREM Group is a real estate brokerage that specializes in probate real estate and trust real estate sales. We are an attorney-owned brokerage (i.e. probate realtors, probate real estate brokers). We do not engage in estate planning, probate or trust administration services. If you have any questions about probate or trust sales please feel free to contact us. If you have a legal question regarding estate advances please contact an attorney; we are happy to recommend an attorney if needed.