Even though the divorce rate in the U.S. is falling, it’s still common for marriages to end. The emotional cost of such a life-changing event is obviously significant, but the financial impact of a divorce can last for a lifetime as well.
For couples that own a home, the decision about what to do with the house after a divorce comes with both personal and financial questions. Is there a sentimental reason for one spouse to keep the home? Is it best for the children to stay in the school district they are in? Is the house affordable on just one spouse’s income?
That’s why the decision is so difficult. In this article, we’ll break down some of the more important aspects of dealing with homeownership during a divorce.
Why your home is so important in a divorce
A home is usually the biggest asset you will have in your lifetime — and also the one you’re most emotionally attached to.
When couples divorce, they need to split up the money and property they’ve accumulated while married. Dividing up these assets and debts often creates stress and confusion, and disagreements about who should get what. That’s even more true for homes. It may be easy to divvy up the balance of a checking or savings account, but dividing up the equity and outstanding mortgage of a marital home is complicated.
3 ways to handle homeownership in a divorce
There are three common ways to handle homeownership involving a divorce. The option that works best for you will depend on how amicable the relationship remains, and whether or not there are children involved in the divorce.
1) Sell the home.
This is often the simplest way to pay off the mortgage and split the proceeds of the money made from the sale. Each party can use their portion of the equity to purchase another home if they qualify for a new mortgage in the future.
There may be tax implications from the sale, so it’s important to consult with a tax professional to find out how the sale will affect your obligations.
2) Refinance the home and buy out the other spouse.
In cases where divorces include children, one of the spouses will often want to keep the family home. This could be to preserve relationships with neighbors, keep children in a school district or simply for sentimental reasons.
But a house is generally the biggest asset a couple has. If one spouse is going to keep it, that can make it difficult to divide the overall pie equally.
A cash-out refinance allows you to get a new mortgage at a higher amount than the current outstanding loan. The difference between the two is paid to you in cash. The amount you can borrow in a cash-out refinance will depend on the loan program you choose.
When evaluating your options, it’s also helpful to know the maximum debt-to-income ratios allowed in a refinanced mortgage. This measures your monthly mortgage payment as a percentage of your overall income. If you bought the house with joint income, you’d need to make sure you can qualify for the new mortgage post-divorce.
Here are three typical refinance loan programs to explore.
Conventional cash-out refinance: The maximum you can borrow will be 80% of the value of the property. The maximum debt-to-income ratio is 45%.
FHA cash-out refinance: You can borrow up to 85% of the value of your home. The debt-to-income ratio is a maximum of 43%.
VA cash-out refinance: If the spouse staying in the house is a veteran, 100% of the value of the property can be refinanced. There is no maximum debt-to-income ratio, but the veteran must be able to show that he or she has enough money left over every month to meet basic needs.
3) Refinance without taking cash out.
In some cases, you might be able to negotiate the division of your assets without having to take any cash out in a refinance. This is a good option if there is very little equity in the home.
Conventional refinancing is often a good fit. If you qualify, here are some “streamline refinance” options that could also work in your situation. They are considered “streamlined” because they often require less documentation.
FHA streamline refinance. This refinancing program is open to people who originally got an FHA mortgage on their home and allows you to remove one of the original borrowers on the loan. However, you need to call your current lender to see if there are restrictions on doing so. There may be requirements for the person staying on the loan to prove they can qualify for the loan on their own.
VA streamline refinance. If a veteran spouse is going to keep the home, it can be streamline refinanced into his or her name. The VA will require a statement from the veteran confirming the ability to qualify on the new loan, especially if the original loan was made with both spouses’ income.
What you’ll need when you go to refinance during or after a divorce
If you and your soon-to-be ex have a mortgage on your current home, there are some very specific things that you’ll need to do if you plan on keeping your house. Your divorce decree will be the primary document used by underwriters for any mortgages you get in the future.
Mortgage underwriters will use the decree as a guide for what debt is counted against a spouse on a future application, as well as when and how income such as child support and alimony can be used as qualifying income for a new mortgage.
If a lender can’t clearly see that debt belongs to your ex-spouse because it didn’t identify the account number of the creditor’s name, the debt will be counted against you and you’ll qualify for less loan. The tips below can help you avoid that scenario.
- Make sure you know every account you have. Every open credit card, every car loan and every real estate asset should be listed on the divorce decree. As the divorce process begins, it’s a good idea to get a “tri-merge” credit report from a credit reporting company, so there is documentation of all the debt that is date stamped. This report includes data from all three bureaus, which is important because information can sometimes vary from bureau to bureau. If more debt shows up later, at least there is a baseline for when it was opened when you first began planning for the divorce.
- Detail all the debt and assets in writing: Each spouse should have both debt and assets identified by account number and creditor name. For example, if you have a car loan, list the make, model and year, the name of the lender, the balance of the loan, the monthly payment and the account number. It’s best to also provide the most current statements with balances even if you have a credit report, since the balances on credit reports may not reflect payments or charges made in the last 60 days.
- Provide your attorney with current asset and income documents: When you’re trying to determine who gets what, the final decisions will likely be made based on who makes what, and which assets will be split such as retirement, stocks, bonds, cash value life insurance, cars, motorcycles, etc. This information will also be needed as part of the mortgage application process, so it’s good to have it organized and ready to provide when it’s time to start the refinance.
- Write down any details of actions to be taken after divorce: If one spouse is going to refinance the property into his or her name, it should be clearly stated with a deadline for when the refinance must be completed. If credit cards are going to be paid off as part of a refinance, the instructions should clarify all the details.
Child support and alimony in future mortgages
Even if you’ve been awarded child support and alimony, you may not be able to use it to qualify as income for a mortgage right away. Be sure to keep documentation of the receipt of any of these sources of income the first year you receive them.
- Three months after a divorce. If alimony or child support is court ordered, they can be used as income to qualify for a new mortgage as long as proof of receipt of the income for three months is provided.
- Six months after a divorce. If the child support or alimony is “voluntary,” meaning your ex-spouse has agreed to pay without a court order, proof of receipt of the income for six months can be used to qualify for a new mortgage.
- Child support agreement with birth dates. In order to use child support to qualify, you’ll need proof that the income will continue for at least three years. The decree should show the children’s ages, but lenders could request birth certificates as well.
There are different ways that divorce liabilities like alimony and child support are counted against you, which may affect your ability to qualify for new mortgage financing. If the alimony you pay is court ordered, be sure to provide a copy of the divorce decree.
Voluntary versus court-ordered alimony and child support. If a spouse opts to pay child support or alimony without any court order enforcing payments, it doesn’t have to be counted against the ex-spouse on a mortgage loan. Court-ordered alimony must be counted, but rather than counting it against the borrower’s total debt, it can be treated as a reduction in income, which doesn’t have as much impact on debt-to-income ratios.
The bottom line
The most important thing to remember with homeownership and divorce is that your responsibility for paying the mortgage only changes if one of you can qualify for a new mortgage loan. Even though a divorce decree may require the mortgage to be paid by an ex-spouse, that doesn’t provide you any protection against the credit effects of a late payment or default.
The same is true of debt that is divided up. If your ex is late on debts the decree states he needs to pay, your credit will still be impacted. A little bit of pre-planning and organization can go a long way to making the divorce refinancing process less stressful, and prepare you for your financial life after divorce.
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