Divorce & Finances: What to do with the home
When going through a divorce and the discussion of the house is on the table, one spouse may want to buy out the other. The worst possible scenario is for one partner to transfer the title to the other while remaining responsible for the loan (or loans). This can lead to prolonged heartache and stress, if not disaster. That’s why we don’t include it as a viable option. But there are cases in which it is possible to sever the legal and financial ties while still allowing one spouse to keep the house. This is typically done through refinancing.
In this arrangement, an entirely new loan is issued to replace the old one. The catch is that the in-spouse must be able to qualify for the loan.
As an example: Bob and Jessica agree that she will keep their house, which is worth $400,000. It is encumbered by loans of $300,000, so the net equity is $100,000. In a typical divorce, the jointly held assets are split evenly, so Bob would be entitled to $50,000 of that equity. (One of the benefits of this arrangement is that the money goes directly to Bob through the settlement process; there is no possibility that the funds will be diverted or “forgotten”). Jessica then needs to secure a new loan for $350,000 to pay to the old loan and give Bob his share of the equity. Will she be able to afford the payments on that increased amount? That is the question she must answer, and which the lender will be examining closely.
Denise Fontyn is a loan underwriter and manager for Provident Bank. She often works with divorcing spouses who are grappling with this issue. “Sometimes,” she says, “one of them really wants to stay in the property and buy the other one out. And that’s what they’re adamant about.” They may qualify for the loan but then have second thoughts when they see the numbers. Fontyn continues, “Once I show them on paper, ‘Look, if you buy them out, this is what your payment’s going to be’— they don’t want to pay that much. It’s above their budget.”
In some cases, the spouses may agree to trade the equity in the house for some other jointly held assets: Bob might agree to surrender his equity in the house in exchange for the couple’s $100,000 stock portfolio. But Jessica would still need to refinance $300,000 to remove Bob from the loan— and then be able to make the monthly payments. Arrangements of this type are common among couples who hold substantial assets together. In such an agreement, taxed dollar amounts must be assigned to all the assets they own together. then, the parties can agree to an equitable division, or if the case goes to court, the judge will order one at his or her discretion.
In community property states such as California, the value of all jointly held assets must be divided absolutely evenly. This is achieved through a process of equalization, in which the value of all assets is calculated and divided 50-50. Other states may allow more flexibility, so long as the arrangement is deemed equitable.
But most divorcing spouses have only a few large assets to divide, with the house being the primary one. So, the proper settlement of the house is crucial to both parties. Oddly, when divorce cases go to trial, the house is often treated as a secondary issue. Courts typically focus on child custody and support issues first, and the house can be put on the back burner — the one asset that should provide the financial bedrock for both ex-partners. This makes it all the more important for you, as one of the divorcing parties, to take up the slack and treat the house with the care it deserves.
What happens when there is no equity to divide? This a reality for many homeowners in today’s real estate market. Often, divorcing partners reflexively defend their rights to the house, when an objective analysis would reveal that there’s nothing to fight over: the house is underwater. Denise Fontyn sees this dynamic often with clients as they haggle over a house that has no equity. “They don’t realize it’s not an asset,” she observes. “It’s a complete liability to them.” In such cases, the sensible course would be to liquidate the obligation as painlessly as possible. That usually means pursuing a short sale, which we’ll discuss in detail later.
For some divorcing homeowners, buying out the other spouse is the obvious right choice. This is feasible when there is substantial equity in the house, and the person can qualify for a loan. Barbara was a prospective client who called me about listing her house for sale. We met at the property and she took me on a tour. It was a well-appointed, comfortable home and I knew it would sell at a good price. In our conversation, she revealed that she owed only $70,000 on the mortgage. As we walked together I began to mull over her situation.
Finally, I asked her, “What’s your goal?”
“Well,” she sighed, “I’d really like to keep the house.”
“Then, let’s work to make that happen.”
Barbara was ideally positioned to keep her home: she could refinance, pulling out enough money to pay her husband his share, and still have a reasonable house payment— far lower than what she would pay to rent another home. Her children wouldn’t need to adjust to a new home, and she could stay in the house she loved.
Excerpt from the book, The House Matters, by Laurel Starks. Unhooked Books.