One of the biggest decisions divorcing couples face is what to do with the marital home. If the breakup is acrimonious, trying to agree on the house and the mortgage can be a nightmare.
The options for divorcing couples depend on a number of factors, such as how their property was financed and titled, whether one partner wants to stay in the home, the amount of equity they have in the home and their credit rating.
Many legal and financial experts say they’re seeing a spike in divorces during the pandemic. Mary Ann Ferreira, CFP, a shareholder at Viridian Advisors in Bothell, Washington, and an expert in the financial aspects of divorce, says she is getting a lot more calls from couples seeking divorce.
“I think there is going to be a surge in divorce because of this COVID,” Ferreira says. “Lots of people are contacting me. It’s very sad, but it sounds like that’s booming.”
Challenges of divorce and your mortgage
Divorce is often a difficult and stressful process, especially when there are assets to split, including a house. Here, we explore different options to help you make the best decision for your circumstances.
Deciding to sell or stay
Deciding who will keep the marital home can get messy if both spouses want to stay in it.
“These decisions go more smoothly when you work with your spouse rather than being at each other’s throats,” says financial adviser Jeremy Runnels, CFP, of West Coast Financial in Santa Barbara, California. “It benefits everyone financially and emotionally.”
Once the couple decides who should get the home after the divorce, they need to make sure the recipient can afford to keep it. It’s smart to take the long view when making this decision.
“It’s prudent to understand the long-term impact of staying in the home, even if it seems feasible over a shorter period of time, because it can really affect other goals you might have,” Runnels says.
Refinancing your mortgage
Some couples decide to refinance a joint mortgage into one name upon divorce. What this does is release the spouse whose name is coming off the loan from responsibility for the mortgage.
However, unless that partner’s name is also removed from the title, they can still benefit from the sale of and equity in the home, so it’s important to not only refinance but also to update the title to reflect one owner. A quitclaim deed is commonly used to remove a spouse’s name from the title in a divorce.
A big factor for many divorcing couples is the reduction in income and assets that help borrowers obtain the best mortgage rates. The good thing is, mortgage rates currently are very low, which could work to a divorced person’s advantage, provided they qualify. The mortgage rate you get after a divorce will depend on the same factors that determine other borrowers’ rates, such as your income, debt, credit score and the market environment.
The spouse applying for the refinance can use only their own income and credit score to qualify, however, Runnels says.
“The lender is going to look at the individual and make sure they’re OK having them as the sole guarantor,” Runnels says. “The issue is can you afford it, and that goes for either spouse.”
If a partner will receive alimony or spousal support, they can use that income to qualify for a refinance, as long as the divorce settlement stipulates that they will receive alimony for at least three years, Runnels says.
If the couple has equity in the home, the spouse keeping the house could apply for a cash-out refinance to pay their ex-partner their share.
“An experienced loan officer may need to think outside the box to achieve these goals,” says Michael Becker, loan originator and sales manager at the Baltimore retail branch of Sierra Pacific Mortgage. “It may entail having the remaining spouse finding a non-occupant co-borrower to qualify for the new loan. It may mean doing a cash-out refinance first to get part of the money to the exiting spouse, then following that up with a home equity loan to get the remaining money due to the exiting spouse.”
Selling your home
A divorce agreement might require the sale of the home and the splitting of profits if the couple doesn’t meet a deadline to refinance the mortgage into one spouse’s name. If neither spouse can afford the mortgage on their own, they may have no choice but to sell. It may be in everyone’s best interest to get rid of the place, pay off the mortgage, collect their share of the profits and start fresh.
In addition, if there’s a dispute over how much the home is worth, selling it is the best way to get the answer.
Besides the mortgage balance, couples should consider the costs they will incur if they sell or refinance the home. These might include Realtor commission, the costs of sprucing up the property to make it more attractive to buyers, real property transfer taxes and capital gains taxes.
Evaluating your home equity
Though selling the home is the only way to truly value it and calculate equity, that’s not always feasible or appropriate. The next best thing is to get a professional appraisal.
Sometimes, however, a couple might not agree on the appraised value. This can cripple efforts to move forward and can mean spending more time and money on attorneys and appraisers.
“In my practice, if the couple is cooperative and can decide on an appraisal company, that would be the best way to determine what the actual equity is in the home,” Ferreira says. “If not, each party should have an appraisal of the home and use an average value when determining equity.”
When you sell your house, you pocket the equity, less selling costs. It’s common for a couple to split the equity, as per their separation agreement, or use it to pay off other debts they accrued together.
Paying off your ex for their share
Let’s say the home is worth $300,000 and the couple owes $200,000 on the mortgage. They have $100,000 equity, so $50,000 will be needed to buy out the other spouse’s share, if they have agreed to a 50/50 split.
To get the cash, one partner refinances into a $250,000 loan in their name only, and uses the $50,000 cash payout to settle up with their ex — but they have to be sure they qualify for the loan.
“Their income needs to be high enough to handle the new mortgage on their own, and the home must have the equity in it to take the cash out,” Becker says. “FHA and conventional cash-out refinances are capped at 80 person loan-to -value, while you can go to 100 percent on a VA loan.”
If you want to keep the house and don’t have the equity to do a cash-out refinance or the money to pay your ex their share, a HELOC or home equity loan could come in handy.
“You could look at doing either a home equity loan or a home equity line of credit, as some lenders will allow you to go to 95 to 100 percent of the value of your home,” Becker says.
Whether you sell the home as part of the divorce agreement or buy out your spouse’s share, capital gains taxes could come into play. This is a tax on the sale of capital assets, such as a home, when the profit exceeds a certain amount.
If you sell the home, you and your spouse can each deduct up to $250,000 of gain from your taxable income, but it applies only to the primary residence you’ve lived in for at least two of the last five years prior to the sale, according to the IRS. Vacation or investment properties don’t count.
The capital gains tax is a progressive tax, similar to ordinary income taxes, notes Francine Lipman, who teaches tax law at the University of Nevada, Las Vegas William S. Boyd School of Law. A wealthy couple might expect to pay as much as 20 percent on the capital gain from a home sale, Lipman says.
“To the extent there are assets to split up, you do want to be aware of any built-in gain,” Lipman says. “There could be a real tax cost.”
On the flip side, a divorcing spouse should be cautious about taking a house that has depreciated.
“You have to be careful which assets you end up taking. Do you want a house with a big loss on it?” asks Lipman, adding that “taxpayers cannot claim losses on the sale of a principal residence [so] that might be a reason to hold onto the house and rent it out maybe, in hopes the market will come back.”
There are also tax considerations regarding alimony payments, which could affect a divorcing spouse’s ability to qualify for a new mortgage or to refinance the mortgage on the marital home.
According to the IRS, the spouse who earns a higher income and pays alimony can’t deduct those payments from their taxable income, but the spouse receiving alimony does not have to declare it as income. (This applies to divorces finalized after Dec. 31, 2018.)
The higher-earning spouse could make a case for paying less alimony, which can lower the receiving spouse’s income to qualify for a new loan, says Runnels.
Conversely, alimony payments might hurt the payer’s income and chances for a mortgage.
“Can a spouse afford the house and all the alimony and child support payments?” Runnels asks. “On the flip side, can the alimony (recipient) afford to keep the house, given they are responsible for all the expenses?”
Lipman recommends hiring a divorce lawyer who understands tax issues or who works with someone who does.
Removing your ex’s name from the mortgage
Only the lender can remove one spouse’s name from the mortgage.
“In almost all cases, the only way to get a spouse off a mortgage is to refinance them off of the mortgage,” says Becker. “If, for some reason, the spouse keeping the house is the only one on the current mortgage, then a quitclaim deed could be executed to get the exiting spouse off of the title to the property.”
Leaving their name on the mortgage can affect the ability of the non-resident spouse to qualify for another loan down the road to buy their own home.
“The biggest factor in qualifying for a mortgage is debt-to-income ratio, and if you’re on another mortgage, that debt is going to be included in your DTI calculation,” says Runnels. “If you’re close to the limit, your DTI will be too high.”
A mortgage is a legally binding contract, separate from a divorce decree, Runnels adds. “If your name is listed on a mortgage, you are liable. You are a guarantor of that mortgage.”
Protecting your credit
Divorce is an emotional, often volatile event, but the worst thing divorcing couples can do is take financial revenge, experts say.
“Many times, out of bitterness, I’ve seen one or both spouses ruin the credit of the other spouse,” says Becker. “They decide that it’s the other person’s problem and refuse to pay bills that may be joint accounts. This can damage your credit greatly and keep you from being able to qualify for any mortgage for a long time.”
Runnels urges divorcing couples to keep paying all their bills through the divorce process to protect their credit.
“Close your joint accounts and get your own accounts set up,” Runnels advises. “If you’re arguing with your spouse over who is going to pay a bill, and you get a ding on your credit, it’s going to be harder to get a loan.”
Finding financial peace
Divorce may feel like the end of the world, but there is life and financial peace after the storm passes. Ferreira knows firsthand. She was an at-home mom about 20 years ago when she got a divorce.
“I had to go back to work and start from square one,” Ferreira recalls. “It took me a while to get back in the black…If the woman has been home with the kids, or taking lesser jobs, from experience, I can tell you there is life after divorce. You can figure it out. It does get better.”