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Divorcing Homeowners – When There’s No Equity to Divide

If you obtained financing at the peak of the market, positive equity may be years away. You still might need to liquidate loans beyond the divorce scenario.
(5 min 19 sec read)

Laurel Starks
Laurel Starks is a divorce real estate specialist. Trained in both mediation and collaborative divorce methods, she speaks frequently on real estate and divorce issues to legal and alternative disputes resolution groups.

Not long ago I received a call from a local attorney who was handling a divorce case. She said the court had appointed me to handle the sale of John and Brenda’s residence.

They owed about $530,000 on their mortgage but figured the property was worth at least $700,000. They had also invested over $100,000 in upgrades, so they felt confident that they’d get their price and come out with plenty of money for each spouse.

Unfortunately, this occurred during a declining market, and the recent comparable sales told a different story. My research revealed that the fair market value was closer to $550,000. Their unrealistic figure was the result of a common misjudgment. As we’ve pointed out, people often base their guesses of value on unreliable information: the asking prices of nearby homes, neighborhood rumors, or sales long past. When they see the real numbers, it can hit like a slap in the face.

The discrepancy in value figures was just the first sign of trouble for John and Brenda. Their loan was one of the infamous “pick-a-pay” loans that became popular during the real estate boom of the early twenty-first century. These instruments allowed borrowers to choose from several repayment plans, with the “easiest” ones incurring negative amortization—that is, the borrowers owed more each month rather than less. As you guessed, that was the option my clients had chosen, so after two years in the home, their unpaid balance was actually $549,000.

It got worse. Their loan had not provided an impound, or escrow, account for taxes and insurance, so we discovered they owed $12,000 in unpaid property taxes. To top it all off, their loan stipulated a prepayment penalty, so if they sold before three years in the home they would owe the bank another six months’ interest. I knew that local home values were dropping fast, so just before delivering this bad news, I did another market analysis. I learned that three new foreclosures nearby had skewed the prices downward again. The home had lost another $50,000 in value—in just one week.

What they had assumed was a comfortable equity sale with substantial proceeds for everyone suddenly became very complicated. There would be no money for either of the divorcing spouses—or for the attorneys, who were counting on the proceeds to cover their fees. It was now clear that we were looking at a short sale. it meant asking the mortgage company to accept whatever the sale proceeds were as full payment of the loan.

Short sales can be a nightmare—and a saving grace. Although they are maddeningly complex, they provide welcome relief for those who need them. They became common in the wake of the housing crisis as rising mortgage defaults led to a full-fledged recession, and property values in some areas plunged by as much as half. Since then the market has improved, and many homeowners have regained equity. But short sales are still common—especially in regions hit hardest by the housing crash—and will probably remain so for some time.

For those who obtained their financing at the peak of the market, positive equity may be years away. But they still might need to liquidate their loans, for any number of reasons. Beyond the divorce scenario, borrowers may experience loss of employment, sickness, the death of a breadwinner, or a job transfer. In these cases, a short sale is often the only good option. It’s usually the best option for the mortgage holders (banks) as well: they dispose of a problem loan without the time and expense of reclaiming the property, marketing it as an REO (bank-owned property), and maintaining it through the long foreclosure process.

But short sales are also perilous. And as anyone who has experienced one can testify, they, too, can take months or years to complete. at leads many distressed homeowners—and real estate agents—to shy away from them. Divorcing homeowners often feel that they simply can’t handle one more stressful thing, and short sales are definitely stressful. So they resign themselves to foreclosure.

This is an understandable sentiment. But as we’ve discussed, making big decisions in the midst of emotional turmoil is a recipe for disaster. And most people don’t fully realize that a foreclosure can deeply hurt their financial prospects for years. In these situations, the best option may be to hand the whole thing over to a professional who is experienced in the process and unconnected to it emotionally. The professional does the work and bears the stress so you can refocus on other pressing issues. Since there are no proceeds to fight over, you literally have nothing to lose in the short term. And in the long term, working with a skilled professional can position you to recover financially much faster than you might imagine. In this regard, timing is critical.

Many distressed homeowners realize that a short sale is probably inevitable, but they choose to put it off. They may hope that rising home values will make it unnecessary, or they may simply prefer not to think about it. But it’s important to think strategically, with the long term in mind. How fast can you realistically expect the home values to rise in your neighborhood? And at that rate, how long will it take before you recover a positive equity position?

To answer that question, you must have precise numbers on your home’s current value and on how much you owe. Your most recent mortgage statement will indicate your unpaid balance at the time of the statement. But the actual payout amount changes from day to day, and may include a range of charges that don’t appear on the statement. Your agent can request a precise payout figure from the mortgage company, which may take from a day to a week to obtain. Once you’ve estimated how long it will take to regain positive equity, the next question may be the hardest: are you prepared to wait that long—just to break even?

Beyond the wasted time, there’s also a very real risk in waiting: your short sale may damage your credit profile at the very moment when you’re trying to rebuild it. It may be better to take the hit early—while your scores are probably down anyway —and then let the recovery begin.

Excerpt from The House Matters in Divorce by Laurel Starks, Unhooked Books.