When a couple divorces, it’s natural for one party to want to stay in the marital home – particularly when there are children caught in the middle. And therein lies a common trap: Divorcees frequently try to hang on to a marital home they can no longer afford. And they run into serious financial difficulties as a result.
If you are going through a divorce, and you’re considering staying in your marital home, think very carefully about how you will be able to continue making the mortgage payments without your former spouse’s income.
Crunch the numbers carefully and be conservative:
If you default on the mortgage, you will damage your credit severely, and make it more difficult to find a more affordable option for housing just when you need it most. Often, trying to stay in a home you can’t afford winds up being far more costly than cutting your losses, selling your marital home, splitting the equity according to your state law, and moving on to a home you can afford to stay in.
But if you do want to stay in the home, and you believe you can afford it, here are some options:
Option 1: The spousal buyout.
If you do believe you can afford to stay, you can “buy out” your partner’s share of the equity yourself. That is, one party purchases the home equity from the other, and stays in the home. In practice, most people need a new mortgage to do this. But if you have the assets available outside of a retirement account, you can certainly do it with cash.
If you need a mortgage, here’s how it typically works:
You have a home worth $500,000, and you still owe $200,000 on the original mortgage.
So, to buy out your spouse’s interest, you will need a new mortgage of $300,000:
$100,000 of it to purchase your former spouse’s share (50%) of your home equity, and;
$200,000 to pay off the balance of the original mortgage (and/or any other liens and encumbrances on the home).
TIP: Remember that with equity buyout mortgage, you are getting a brand-new loan. You’re not just taking over the payments. The original interest rate and monthly payment doesn’t carry over into the new loan. You have to recalculate everything. With spousal buyout, you’ll need to qualify for the loan on your own, without your former spouse’s income on the application. You can count alimony and child support expected to last at least three years. But you can’t count your ex-spouse’s income. Having a lot in home equity doesn’t help you qualify, either. Mortgage lenders generally don’t look at that. Though, if you have at least 20 percent, you won’t have to pay private mortgage insurance premiums (PMI).
Advantages of a spousal buyout mortgage:
Chances are good your interest rate will be better today. That’s great for cash flow –and lots of people come out of a divorce with reduced household income, which gives them a much-needed increase in cash flow!
Disadvantages of a spousal buyout mortgage:
If you’re well into your mortgage term, and you refinance into a 30-year term, it will take much longer to pay off your loan. Most of your new payments will be going to interest for a while, not the balance, and it will take longer to build up home equity.
Furthermore, by refinancing to a longer remaining term, you may pay much more in interest over the life of the loan – even at lower interest rates.
Option 2: Take over the payments.
The second option is to take over the payments yourself. To do so, you would usually need to take your former spouse off the mortgage – a process called assumption. That is, you’re assuming the mortgage onto yourself.
This strategy has the advantage of simplicity, and if the lender approves, allows a clean break with the other partner.
For this to be a good option, your loan has to be assumable. Your mortgage promissory note will tell you whether your loan is assumable or not and under what conditions. You should also have a mortgage with a very low-interest rate and payment terms.
If the loan is assumable, the fees with an assumption are usually lower than an outright refinance. There are no new appraisals or title fees required.
In practice, this isn’t very common. VA mortgages are still assumable, with the lenders’ approval. But most other mortgages have not been assumable since 2008.
Even if your loan is assumable, you’re going to have to go through underwriting all over again. To release the other party from the loan, the lender will first run a credit check, look at your debt-to-income ratio, and verify that your income alone, with your spouse out of the picture, is sufficient to cover the mortgage payment.
WARNING: If it’s your soon-to-be ex-spouse who wants to stay in the home, and you anticipate being the one to move out, be very cautious about any arrangement that still leaves your name on the mortgage. If you fail to have your name removed from the loan, and merely agree that your ex will continue the payments, and it doesn’t happen for whatever reason, you are still responsible. Your ex-spouse’s late payments will damage your credit. Legally, the safest thing to do is keep your name on the title until you are formally released from the mortgage obligation.
Note: As of this writing, in early May 2020, interest rates are close to historic lows – right around 3.53 percent for a 30-year loan, according to Bankrate. So, it may not even make sense to assume the mortgage if you can get a better rate by refinancing on your own.
Furthermore, even if you can assume the loan yourself, any home equity you have between you and your spouse has to be accounted for, so you each walk away from the marriage with your fair share.
Option 3: Sell the home.
Sometimes the numbers don’t work out. No matter how badly one spouse wants to stay in the home, it’s just not affordable. If you can’t qualify for a mortgage on your own, or your income is not likely to be consistent, then the best strategy is often to sell the home outright. The court will divide the equity between you, along with your other assets, according to your state laws.
If you receive cash proceeds from the sale (your equity after selling), you can use it for any purpose you like.
The first order of business will be finding a new home. You can use the proceeds towards a down payment on a more affordable home, for example. Or you can pay off high-interest credit cards and knock out some debts completely. Eliminating monthly payment obligations will help improve your debt-to-income ratio fast. So, you’ll be able to afford a bigger mortgage.
As one of just a handful of Certified Divorce Real Estate professionals in Illinois, I can help you work through the difficult real estate and mortgage issues that often come up as couples divorce. Working with your attorneys and mortgage broker, I can also help you avoid many costly mistakes that well-meaning but untrained agents make when it comes to divorce, real estate, and mortgages.