Divorce and Your Mortgage – What you need to Know

Divorce and Your Mortgage – What you need to Know

The Big Questions

There are two major questions you will face when dealing with the marital residence during divorce:

  1. Who keeps the house?
  2. What happens to the mortgage loan?

Before we jump into the options, there is one important thing to understand: the house and the mortgage loan against the house are two separate things.

If you have a joint mortgage, and it is agreed that one of you will be staying in the house, you will both still be liable (legally responsible) for paying the mortgage loan until the necessary legal and financial steps are taken. This is true even when there is a court order for only one of you to pay the mortgage. The lender is not a party to your divorce and, if your name is on the mortgage, you are 100% liable for that loan if your spouse/former spouse stops making payments...even if the judge says otherwise.

Here are your options if one of you will be keeping the marital residence in your divorce:

Option 1 – MORTGAGE ASSUMPTION: One Spouse Keeps the House and Assumes the Mortgage

If you don’t intend to sell the marital residence, and it is agreed that one spouse will be staying in that home, an assumption is your best option.

What is an Assumption? An assumption means that one of the spouse’s names comes off the mortgage loan (they are released from liability). It is not an entirely new mortgage. It is a change to your existing mortgage loan.

Are All Mortgage Loans Assumable? No. VA (military) and FHA loans are always assumable. For most other mortgage loan types, less than 50% are assumable. You need to check with your lender to determine if your mortgage is assumable. Some people are also able to find this information in their closing documents. Don’t take the first answer you are given, though. Be diligent. Lenders prefer refinances over assumptions, so ask a few different people at your lending institution to be sure you are getting the correct information. https://www.investopedia.com/terms/a/assumablemortgage.asp

Must Qualify Individually. Even though an assumption is not really a new mortgage loan, the lender will still scrutinize the staying spouse’s credit rating, income, and other financial criteria to be sure that spouse has the financial ability to make the payments.

Timing. The assumption process cannot be started until your divorce is final. The signing of your settlement/separation agreement is not enough. You must be fully divorced and have a settlement agreement that sets forth the terms of the agreement to assume.

Interest Rate Does Not Change. The beauty of an assumption is that your interest rate will not change. This is why people do an assumption versus a refinance, even though the wait time is greater.

Leaving Spouse is No Longer Liable on Mortgage Loan. An assumption is a foolproof way of releasing the leaving spouse from liability on the mortgage loan.

Cash Buy-Out Not Available. With an assumption, there is no way to pull cash out the house (as there is with a refinance). That means that, if there is going to be a buy-out of the leaving spouse’s agreed share of the equity, that money will need to come from somewhere other than the equity in the house.

Fees. Even though an assumption is basically just the removal of one spouse’s name from the original mortgage loan, they lenders still charge a fee. You can expect to pay 0.5-1.0% of the home’s market value plus fees for a current appraisal, title insurance, and other miscellaneous fees.

Option 2 - REFINANCE: One Spouse Keeps the House and the Mortgage is Refinanced into that Spouse’s Name

  1. Refinance Defined. A refinance is just a fancy way of saying that the staying spouse must get a new mortgage loan. A refinance requires the same steps as when you applied for your original mortgage.

  2. You Need to Qualify for a Mortgage Loan On Your Own. For the staying spouse to qualify for this new mortgage, they must meet all of the criteria required by the lender in terms of credit rating, income, and all of the other criteria that demonstrates an ability to make the payments.

  3. The Timing is Essential. A refinance application can be started with the lender any time during the divorce settlement process. It is usually best, however, to wait until your settlement agreement is signed before starting the refinance process. You do not need to wait until you are divorced for a refinance.

  4. Your Interest Rate Will Change to the Current Rate. With a refinance, the new mortgage will be at the interest rate at your time of refinance. If that rate is higher than your current rate, that can be a big problem. For example, if your mortgage loan rate goes from 2.75% to 6.75%, your monthly costs (for principal and interest only, not taxes or insurance) will go from about $1,630 to $2,595, which is an almost 60% increase at $962 more per month.

Option 3 – MAINTAIN JOINT MORTGAGE LOAN

Keeping a joint mortgage loan with your ex, for a specific period-of-time, is an option...but not a very good one. It is only recommended if there is not any other reasonable way to free yourselves from this type of joint debt.

  1. Both you and your ex remain liable (legally responsible) for your joint mortgage loan -- no matter what the divorce paperwork says. The lender is not a party to your settlement agreement or divorce. You and your ex will both remain liable on the mortgage loan as long as both of your names are on that debt. The divorce courts cannot help you if your ex stops paying the mortgage and ruins your credit. The best you can do, if the spouse who is supposed to pay the mortgage stops paying, is go to the divorce court and try and force them to pay...but that is often a long process and, if your ex has no money, it will be on you to make those payments or face a potential foreclosure.

  2. Keeping yourself tethered to your ex by a mortgage loan delays your independence. Maintaining a joint mortgage loan means that you will have to count on, cooperate with, and be reliant on your ex in a way that might feel cramped and controlling. This is especially difficult when your ex was already a controlling or irresponsible person. Also, if you have children for whom you are sharing custody, adding a joint mortgage loan into the mix might not give you the space you need to properly move on as an independent person.

  3. Your debt-to-income ratio (a number that impacts your credit scare) will be impacted. If you want to show a low debt to income ratio -- which is often important if you want to buy a new home or car -- you might have a difficult time meeting the lender’s criteria if you choose to remain on the loan for the marital residence. In other words, you will be asking the lender to provide you with a loan when you are already liable for the mortgage for the marital residence. Even if you can show, in your divorce decree, that your ex is responsible for paying the mortgage on the marital residence, this will not change your debt-to-income ratio. https://www.bankrate.com/mortgages/what-to-know-about-divorce-and-mortgage/#considerations

  4. Despite the drawbacks, there are certain circumstances where maintaining a joint mortgage with your ex will make sense. Such as:

    1. You don’t want your kids to have to move from their home and neighborhood, and all homes in that area (purchases and rentals) cost more than either one of you can afford on your own. Your ex will need to agree that this is important for the children.
    2. You don’t want your kids to have to change school districts, and all homes in that area cost more than either one of you can afford on your own. Your ex will need to agree that this is important for the children.
    3. You or your ex have strong feelings about staying in the marital residence, but cannot individually qualify for an assumption or refinance. This is usually done on a short-term basis to allow the spouse who is staying in the marital residence to get their bearings after an emotionally charged divorce.
    4. You and your ex agree to sell the house, but are waiting for the market to improve before you put it on the market.

  5. In your settlement agreement, you need to make the terms of maintaining your joint mortgage loan very clear. Here are the big ones:

    • Include a clear deadline for when the staying spouse must complete the assumption or refinance. That deadline should be for the completion of the assumption or refinance (not just the submission of the application).
    • Determine the consequence of missing the assumption/refinance deadline, which is usually an immediate listing of the house for sale. Be clear on what happens if the staying spouse does not qualify for an assumption, refinance, or if there is simply a change of mind. Usually, the consequence of not meeting the deadline is an immediate listing of the house for sale. For that reason, you should consider the deadline falling at a time of year when houses tend to sell best in your area.
    • State who is responsible for making the actual mortgage loan payments to the lender.
    • Clarify who is responsible for paying the assumption or refinance fees and costs.
    • State what happens if the paying spouse misses a mortgage loan payment. Be clear. Mandate written notification if a payment is missed. You will also want to state the consequences of missing a payment/s, which is usually that the house must be sold. Often, it is upon missing two payments that the house must go on the market for sale.
    • Determine how you will handle the buy-out of the equity in both an assumption/refinance situation and if the house is sold. For example, if the staying spouse will be buying out the non-staying spouse’s equity interest, will that amount be based on the fair market value at the time of settlement or at the time of the assumption or refinance? If the house is sold, will the sale price determine the buy-out amount? How will you factor for all of the mortgage payments made between the time of settlement and the assumption/refinance or sale in terms of the equity to be divided (which will probably be higher due to those payments)?
    • Decide if the non-staying spouse will have a say-so in how the house is maintained for that period of time during which their name is still on the mortgage loan.
    • Plan for how you will share the cost of repairs and big ticket items, such as a new furnace, new roof, sewer back up, mold problems, etc.
    • Determine which one of you will have the right to claim the mortgage interest and real estate tax deductions, as applicable.

Option 4 - Sell the House

Sometimes, the best, or only, option is to sell the house. This is especially true when:

  1. Interest rate too high. Your mortgage is not assumable, and neither you nor your ex can afford the mortgage at the new interest rate upon refinance.
  2. Failure to qualify for a new loan. Neither you nor your ex qualify, on your own, for a mortgage loan due to credit or income issues.
  3. Costs of maintenance and repairs. Neither you nor your ex can afford to maintain the house on your own. That includes both regular upkeep and big repairs.
  4. Fresh start. You both want a clean break.

How to Manage Mortgage Payments During the Divorce Process

Until you’ve refinanced/assumed the mortgage loan, or you have closed on the sale of the marital residence, you will need a clear plan for how the mortgage payments are going to be paid.

Will you share the monthly payments for a period of time? If so, you need to determine:

  1. What percentage will each spouse pay?
  2. Who will make the actual payments to the lender?
  3. How will the reimbursements be made?
  4. What day of the month will the reimbursements be made?
  5. What happens if mortgage loan payments get missed? You need a plan.

What happens if mortgage loan payments get missed? You need a plan. Most of the settlement agreements that I write state that, whether the payments are being shared or not:

  1. One late payment requires written notification to the non-paying spouse.
  2. Two missed payments result in the house being listed for sale.
  3. You might also want to state what happens in a situation where the paying spouse needs money from their ex, in the form of child support, spousal support, or an agreed financial contribution to the mortgage payment amount, in order to have the money to make those mortgage payments.

Need more help thinking through how to manage your mortgage loan situation before or during your divorce?

Give me a call at 571-220-1998. I can help you guide you through the decision-making process.