Loan Assumption vs Refinance: Making the Best Choice in Divorce
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Richard Haddad Managing EditorClose
Richard Haddad Managing EditorRichard Haddad is the managing editor of HomeLight.com. He works with an experienced content team that oversees the company’s blog featuring in-depth articles about the home buying and selling process, homeownership news, home care and design tips, and related real estate trends. Previously, he served as an editor and content producer for World Company, Gannett, and Western News & Info, where he also served as news director and director of internet operations.
At HomeLight, our vision is a world where every real estate transaction is simple, certain, and satisfying. Therefore, we promote strict editorial integrity in each of our posts.
In a divorce, the largest asset most couples divide is their marital home. Typically, one spouse opts to stay in the home, buying out the other’s share of the property’s equity. This buyout is often made possible through refinancing the mortgage, which also removes the departing spouse’s name from the loan and title. However, in this high-interest-rate market, couples are weighing “loan assumption vs. refinance.”
The option of a loan assumption can allow the buyout spouse to retain the original mortgage’s payment, interest rate, and term, while still removing one party from the loan and ownership documents.
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Understanding refinancing in the context of divorce
As noted, refinancing during a divorce is a common strategy for the spouse who wishes to keep the marital home. Essentially, this process involves replacing the existing mortgage with a new one, which can serve two primary purposes.
- Refinancing enables the buyout of the other spouse’s equity in the property, providing them with their share of the home’s value.
- Refinancing removes the departing spouse’s name from both the mortgage and the home’s title, solidifying sole ownership for the remaining spouse.
In a typical scenario, the spouse staying in the home applies for a new mortgage. If approved, this new mortgage pays off the existing loan, and any additional funds secured through the refinancing are used to pay the equity owed to the departing spouse. This arrangement provides a clear financial separation of assets and allows for a clear transfer of home ownership.
However, the current market’s higher interest rates bring a significant consideration to the forefront. To illustrate the impact of refinancing at a higher interest rate, let’s consider a scenario involving a $300,000 mortgage balance on a $450,000 house. The existing mortgage has an interest rate of 3%. If the spouse retaining the home refinances for a buyout at a 7% interest rate, here’s how the financials might look:
Existing mortgage at 3% interest rate
- Monthly Payment: $1,265
- Total Interest Over 30 Years: $155,332
Refinanced mortgage at 7% interest rate
- Monthly Payment: $1,996
- Total Interest Over 30 Years: $418,527
In this example, the monthly payment increases by $731, and the total interest paid over the life of the loan more than doubles, clearly illustrating the financial impact of refinancing at a higher interest rate. It also demonstrates why, in a high-interest-rate market, the option of loan assumption might be more appealing.
Loan assumption as an alternative
In the face of higher interest rates and their impact on refinancing, loan assumption emerges as a potentially more favorable option for divorcing couples. A loan assumption involves one spouse taking over the existing mortgage under its current terms, including the interest rate, monthly payments, and remaining loan duration.
This option can be particularly appealing in situations like our previous example, where refinancing would significantly increase both the monthly payments and the total interest paid over the life of the loan.
The Garn-St. Germain Act
The Garn-St. Germain Act, enacted in 1982, can play a pivotal role in the assumption of mortgages during a divorce. Traditionally, mortgage assumption was a common practice, but this federal law allowed lenders to enforce “due on sale” or “due on transfer” clauses in their contracts, regardless of state laws. Fortunately, the Act includes exceptions where lenders can’t demand immediate loan repayment, notably in cases of death or divorce. In a divorce situation, the transfer of property and mortgage assumption may not activate the “due on sale” clause, often found in conventional loans. Furthermore, many lenders modify or waive standard loan qualification requirements in divorce cases, acknowledging the unique nature of these circumstances.
The key advantage of a loan assumption in a divorce context is the preservation of the original loan’s terms. For the spouse who wishes to keep the home, assuming the existing mortgage means they can continue making payments at the original, potentially lower interest rate. This can result in substantial savings, especially when current market rates are significantly higher.
However, there are important considerations to keep in mind with loan assumptions. Not all mortgages are assumable, and the ability to assume a loan depends on the specific terms set by the lender. In addition, the spouse taking over the mortgage must qualify for the loan on their own, which involves a traditional credit check and financial assessment by the lender. The goal is to be certain the remaining spouse can reliably handle the mortgage payments as the sole borrower.
Another key aspect that must be considered is the legal and financial responsibility for the loan. In some cases, a loan assumption might not fully absolve the departing spouse from the debt responsibility if the loan goes into default after the divorce. It’s important to carefully review the terms of the assumption and ensure that it lines up with all the agreements made in the divorce settlement.
Loan assumption can be a practical and financially prudent choice for divorcing couples, especially in a high-interest-rate environment. By understanding its benefits and limitations, couples can make a more informed decision that best suits their individual circumstances and financial futures.
Comparing loan assumption and refinancing in divorce
When divorcing couples face the decision of how to handle their marital home, understanding the differences between loan assumption and refinancing can help guide your choice. Let’s look at some things to consider for each of these options.
Financial implications
- Refinancing: This involves taking out a completely new mortgage at current market interest rates, which can be higher than the existing loan’s rates. The most common concern is that refinancing might lead to increased monthly payments and a higher total interest cost over the life of the loan, as we illustrated in our earlier example showing a $300,000 mortgage.
- Loan assumption: This option allows one spouse to take over the home’s current mortgage with its original terms (with the interest rate often being the most pivotal). If the existing mortgage had a lower interest rate than current market rates, the financial burden could be significantly less when compared to traditional refinancing.
Process and requirements
- Refinancing: The spouse retaining the home must qualify for a new mortgage, which involves credit checks and financial assessments. The process includes closing costs and potentially other fees, and it results in a completely new mortgage agreement.
- Loan assumption: The spouse assuming the loan must also qualify based on creditworthiness and financial stability. However, the process typically involves fewer administrative steps and lower costs than refinancing. Here again, not all loans are assumable, and the terms can vary based on the lender.
Impact on ownership and liability
- Refinancing: This method effectively removes the departing spouse’s name from both the loan and the property title, which can provide a clean break in terms of financial and legal responsibilities.
- Loan assumption: While it transfers the mortgage payment responsibility to the spouse who keeps the home, it’s vital to ensure that it also removes the other party’s legal obligation. In some cases, such as with a VA loan, the departing spouse might still be liable if the loan goes into default unless the assumption agreement explicitly states otherwise.
Suitability in different scenarios
- Refinancing: May be more suitable if the remaining spouse can secure a mortgage with favorable terms, or if there is a need to cash out equity for the buyout.
- Loan assumption: Ideal in situations where the existing mortgage has favorable terms compared to current market rates, and where the spouse assuming the loan can afford the payments and qualify for the mortgage on their own.
Equalization payments
When considering the costs of assuming a mortgage in a divorce, it’s essential to factor in any required equalization payments. In many divorce settlements, if one spouse is assuming the mortgage and keeping the residence, the other spouse may be owed an “equalization” for their share of the community interest in the property. This involves compensating them for their portion of the home’s existing equity.
To manage this equalization payment, options might include using personal savings, selling another asset, or even considering refinancing the home. The need for a substantial equalization payment can significantly influence the feasibility of assuming the mortgage. Incurring additional debt to cover this payment can impact your financial stability post-divorce.
Partner with professionals for proceeds and peace
The choice between home loan assumption and refinancing in the context of a divorce largely depends on these factors:
- The circumstances of the couple
- Each individual spouse’s financial situation
- The terms of the existing mortgage
- Current market conditions
As you consider which path to travel, it’s wise to consult with professional financial or legal advisors. They can help you make decisions that align with your long-term financial health and personal goals post-divorce. Expert guidance can also provide clarity and calm during what can be a very emotional and turbulent time.
If you decide to sell your marital home, or if you’re looking for a new home in a new location, HomeLight can connect you with a top agent in your market, including a Certified Real Estate Divorce Specialist (CDRE).
Header Source: (Roger Starnes Sr / Unsplash)
