Managing Your Mortgage During Divorce

One unfortunate reality of marriage is that about half of them end in divorce, a world-changing experience that forces partners to divide assets and debt. Divorce rates for second and third marriages are even higher.

The end of a marriage complicates personal finances, especially when mortgage loans are involved. Many couples, especially those with two incomes, have no choice but to sell their homes, pay off their loans and split the remaining money. Others opt to let one partner keep the property, often through a deed transfer and a reassignment or refinancing of the mortgage.

Deciding what to do with a home is financially and emotionally stressful. But for partners willing to cooperate, the choices don’t have to be traumatic or embittering. Those willing to face the inevitable and negotiate can avoid a cost-filled legal battle.

Removing Your Spouse from the Mortgage After Divorce

Many couples who own their home have them titled in both their names. Similarly, they also have a mortgage under both names — though not always.

If neither partner can afford to pay the mortgage and maintain the home after a divorce, selling might be the only option. However, if one person has the financial means to keep the property, the couple might consider re-titling the deed and either refinancing or reassigning the mortgage.

It’s important to realize that a divorce doesn’t release the couple — or either partner — from the mortgage. Financially preparing for divorce, especially for couples with significant assets, requires an accounting of assets and debts, a decision on how to split them equitably and the execution of legal documents to divide all the assets.

If you want to keep your home and your divorcing partner agrees, you’ll take two steps:

1. Re-title the property, which involves a quitclaim deed, with which your partner will surrender their interest in the real estate and transfer the property to your name.
2. Refinance or reassign the mortgage to your sole ownership.

Take these steps in sequence. Step 1 is drafting a divorce agreement and submitting it for court approval. The agreement is a blueprint for how your split will occur, including what you’ll do with jointly owned real estate and debt associated with it.

If one partner keeps the real estate, the other needs to sign a quitclaim deed transferring the title to that person. Once the deed is filed, the divorced couple needs to resolve the mortgage.

You can resolve the mortgage in two ways:

1. Remove one spouse from the mortgage, relinquishing ownership of the mortgage
2. Refinance the home loan and take a new one in the name of the spouse keeping the property.

Dealing with the mortgage is important. It’s possible to quit-claim a deed and for both divorcees to remain on the mortgage. If one spouse stops paying the mortgage, the other must make the payments. Failing to pay the loan leads to default and foreclosure.

To avoid future issues, transfer the mortgage to the partner taking ownership. Lenders sometimes allow this procedure, but not always. If your lender says no, you’ll probably need to refinance, a more complicated process requiring you to apply for a new loan in your name only and use proceeds from the new loan to pay off and close the old one.

Selling Your Home After Divorce

Financial experts say that selling your home is the second-best option after a divorce. (The No. 1 option is one spouse keeping the home.) Selling the home makes for a clean financial break between the spouses, giving both a chance at a new start with cash on hand.

A divorce agreement should spell out details you must follow about a home sale, especially for the division of proceeds. Regardless, selling a home after a divorce can come with complications.

First, market conditions may not be as favorable to sell now as they were when the couple bought their home. Interest rates may be higher, which can slow down the housing market, or home prices may be lower. (Nobody wants to sell a home at a loss.)

Second, you and your spouse must agree on a listing price for the property, how to share the sales costs, and, if you don’t sell the home on your own, who will be the listing agent. That agent will be responsible for communicating with both spouses consistently throughout the process.

Also, if a prospective buyer learns that you’re selling the house because of a divorce, the buyer sometimes can use that leverage to negotiate a lower sales price. So, that’s a lesson: If you’re selling a home because of a divorce, keep that fact to yourself. That way, buyers can’t use it against you in the home-buying process.

When you decide to sell, take action to help a sale happen. Make sure the home stays furnished — but not over furnished. Ask your realtor to suggest furniture additions or subtractions that make the house look its best.

Also, if the sales process turns longer than anticipated, make sure the home stays free of clutter and smells good. (Cooking an occasional pan of cinnamon rolls or brownies does wonders, especially right before an open house.)

Another potential complication comes in the form of taxes. The IRS has a capital gains exclusion on the proceeds of home sales: $500,000 for couples, $250,000 for individuals.

Two key tax notes to remember:

1. If you and your spouse live together in the home as your primary residence, you should be able to shield $500,000 from any profits you make on the sale. If you file separately, you should each be able to exclude $250,000.
2. If one spouse moves out of the home before a divorce is final, a two-year residency requirement (two years out of the previous five) could come into play and negate the tax savings.

If you, by your constant living in the home through the divorce process, can take the tax exclusion while your spouse cannot, you may be asked to make up for the financial discrepancy in your divorce settlement.

Divorce attorneys say it’s best to sell the home as soon as possible. Regardless, a delayed home sale should not hold up the divorce. If the house remains on the market after a completed divorce, the divorce agreement will probably spell out the proportions for the division of proceeds.

Refinancing After Divorce

There are two ways to remove a divorced partner from a mortgage: getting a release of liability from the lender or refinancing the mortgage. Refinancing is a more common tool. It cancels the existing mortgage and requires the spouse to keep the home to get a new mortgage. Replacing the two-party mortgage with a new one can allow the person refinancing the loan to take out cash to cover debts.

Here’s an example: Joe and Johanna divorce, and Johanna opts to keep the house, which appraises at $300,000. The divorce agreement requires Joe to receive half the value of the house in cash after the unpaid balance of the mortgage is deducted. The home has an unpaid mortgage balance of $100,000, leaving $200,000 in equity. So, Joe is entitled to half of the equity — $100,000.

To keep the home and pay Joe, Johanna replaces the current mortgages with a new one that will enable her to pay Joe his equity share. She secures a new $200,000 mortgage, using $100,000 to satisfy the original mortgage and the remaining $100,000 to pay Joe his share of the sale.

Joe and Johanna each end up with $100,000 — his portion in cash, hers in home equity.

One frequent disadvantage of refinancing is that the loan taker assumes a longer payoff period. Instead of having a mortgage paid off in seven years, Johanna needs a more expensive mortgage that she can afford, one with longer terms. She settles on a 15-year or 30-year mortgage.

If she sells the dwelling later, she keeps all the remaining equity after the mortgage is satisfied. But besides paying more closing costs, she will also pay more in mortgage interest. If she refinances at a higher price to pull cash out of her equity, she may have to pay primary mortgage insurance (PMI).

Other costs of refinancing can also include an updated property appraisal, a survey and a home inspection. They can also include buying points: extra payments that borrowers make to lenders to secure a lower interest rate on the loan.

Another fact of refinancing is that the borrower must again qualify for a mortgage. That process involves lenders assessing credit scores, credit history, income and debts.

A real concern is that one spouse may have a significantly reduced income after a divorce and may not qualify for the loan size they want. However, income now can include spousal support, such as alimony or child support.

Do I Have to Refinance After a Divorce?

You don’t have to refinance a home after a divorce. Many couples decide that neither of them can afford the home — or want it — and choose to sell it. Their lender also might allow the partner who keeps the house to assume the mortgage, relieving the other partner from any financial obligation to it.

Sometimes, divorcing couples reach other agreements. They both might continue to own the home jointly and not change the mortgage even though only one of them lives in it. Or one spouse quitclaims a deep to the other spouse who will live there, but the other partner remains on the mortgage. However, this strategy puts the departing spouse at financial risk.

Refinancing is often the best solution, since taking a new mortgage can generate enough cash-out to cover the vacating spouse’s equity. But it’s not foolproof. The spouse hoping to keep the home will have to qualify for a new mortgage on their own financial merits. That means reaching a lender’s credit benchmarks without their partner’s help.

Criteria for refinancing include:

• A credit score of at least 620 for a conventional mortgage (a slightly lower score for an FHA loan)
• A maximum loan-to-value ratio of 97% for a conventional loan and 97.75% for an FHA loan
• A typical maximum debt-to-income ratio of 43% or better

Since what might have been a two-income household becomes a single-income household after the divorce, it’s possible that the spouse who wants to stay in the home won’t have enough income to meet the mortgage requirements.

The divorce will further reduce the spouse’s cash on hand because it will divide any jointly owned savings and investment accounts. The situation is worse if the couple had also to split up their joint debt.

Decreased income and savings and a higher personal debt load — both of which are common in a divorce — might make finding a mortgage with affordable payments difficult or impossible.

Finally, if most of the couple’s credit accounts were in the name of the spouse leaving the home, the one wanting the keep the property might not have a sufficient individual credit history to qualify for a loan.

Mortgage Transfer

Transferring an existing mortgage to one spouse might be the easiest way to settle the housing issue. Lenders usually want copies of the divorce decree and a properly executed and filed quitclaim deed to transfer the mortgage.

Taking over a mortgage is called a mortgage assumption. Lenders don’t have to grant assumptions. So, it’s important for you and your ex to review the terms of an assumption if a lender agrees to allow it.

Sometimes, the spouse relinquishing interest in the home might still be liable if the spouse keeping the property defaults on the mortgage or makes late payments. This could damage the non-owning spouse’s credit even though that spouse has no interest in the property. To avoid this, the lender should grant a release from liability to the spouse who is quitclaiming the property.

Have the lender remove the mortgage liability of the non-owning spouse from that person’s credit report. If the spouse keeping the property misses mortgage payment deadlines and the other spouse still has the property on his or her credit report, it could cause a major drop in that person’s credit score.

If the divorce causes a financial hardship and missed payments, lenders sometimes offer a mortgage modification.

Lenders are often reluctant to release a responsible party from the loan, and they’ll want evidence that the remaining borrower can repay the loan on his or her own. The lender almost certainly will charge transfer fees.

Although a mortgage assumption avoids the cost and uncertainty of refinancing a mortgage, its terms are important. Because refinancing and mortgage assumptions are complicated, it’s a good idea to discuss the options with a mortgage broker and a financial planner — then decide what’s best.