“Who gets the house?”
That’s one of the toughest questions married homeowners need to answer during divorce proceedings. Unfortunately, it’s not so simple as negotiating ownership between the two of you (and your lawyers) when the house in question still has a mortgage on it.
In most cases, mortgage companies won’t let you simply remove one spouse from the loan and the deed.
“The transfer of title after a divorce is a very common and tricky problem,” explains Theresa Guettler, branch manager with Caliber Home Loans. “The right thing to do is to refinance after the divorce.”
The spouse staying in the house will need to refinance the mortgage in order to remove their ex from all rights and obligations to the property, but that’s not as simple as it sounds.
So should you refinance the house after divorce? Decide with the help of these answers to the 5 biggest questions asked by those planning to refinance the house after a divorce.
What are the requirements to refinance the mortgage in a divorce?
The process of refinancing during a divorce is exactly the same as refinancing without those extenuating circumstances. So, the documentation you’ll need mainly varies depending upon the loan type that you’re refinancing into.
As with any mortgage, you’ll need to show proof of income, proof of insurance, proof of debts and assets, and your current credit score.
The real difference in refinancing during (or after) a divorce is that you’re removing one party from the obligation to the loan debt—which means you’ll also need to buy your spouse out of their share of any equity.
“Mortgage companies don’t just drop borrowers,” says top-selling agent Kevin Shaw who’s sold over 83% more properties in Johnstown, Colorado than the average agent. “If refinancing to buy out your spouse is an option, it’s very similar to qualifying for a loan from the beginning. But instead of qualifying with two incomes, you have to qualify on your own.”
Refinancing to qualify for a new mortgage on a property that took you two salaries to buy in the first place isn’t easy. Plus, you won’t have access to all of your home’s equity to help you secure the new loan.
“Refinancing during a divorce is tough. If you bought your home for $300,000 and now it’s worth $600,000, you don’t have access to that $300,000 in equity you’ve built up to help with the refinancing,” explains Shaw. “Your spouse has claim on half of that equity.”
Not having access to the full amount of home equity can hurt your refinancing chances in other ways, too.
How does home value impact refinancing?
So chances are, your home is probably worth more now than it was when you and your spouse first purchased it.
If you were to sell that home as part of your divorce proceedings, you and your spouse would split the profits from any existing home equity. But when one party wants to keep the property, the other party will still want the cash they would’ve gotten by selling the place.
For most, the only way to get the money to pay the equity owed to the other party is by adding that balance into the new loan.
Buying your spouse out means refinancing a loan amount that’s a lot larger than your existing mortgage debt.
For example, let’s say you still owe $250,000 on the house that’s now valued at $600,000. That means you have $350,000 in equity built up that you’ll likely have to split 50/50 with your ex. So when you refinance, you’ll have to do at least a $425,000 cash-out refinance.
Because the new mortgage needs to cover the $250,000 still owed to the bank. Plus you’ll need $175,000 in cash out of the loan to cover the 50% equity owed to your ex.
And don’t forget the refinancing fees that’ll increase the loan amount even more. The Federal Reserve reports that you’ll pay anywhere from 3-6% of your outstanding principal in refinancing fees.
However, according to Guettler, those fees may be closer to 1-2%, depending on your mortgage company.
That means you’ll be paying an additional $4,250 to $25,500 in refinancing fees—but you don’t necessarily need cash up front to cover them. Your mortgage company may be able to wrap those fees into the balance of your new loan.
The bottom line is, the principal balance of your refinanced loan is typically going to be significantly higher than your existing mortgage—which may mean higher monthly mortgage payments.
The only alternative is bargaining that new loan amount down with your spouse. You might do this by making other concessions during the divorce, such as surrendering your claims to other financial assets like 401Ks or other shared retirement benefits, or giving up rights to alimony.
How do interest rates impact your mortgage refinance?
Mortgage rates are always changing. They can vary because of loan type and your choice of lender, too.
Since interest rates aren’t static, there’s a good chance current rates aren’t the same as they were when you first took out your existing mortgage.
“You don’t get to refinance your home with the same interest rates that you had when you bought the home,” explains Shaw. “If interest rates have increased substantially since the time that you purchased, that may be a limiting factor for you whether or not you can even afford to keep the property.”
Higher interest rates are one of the top reasons that divorcing homeowners don’t refinance or even deal with selling the home and buying new properties at all.
But putting off refinancing because of interest rates is a huge mistake.
“Refinancing from a 3.75% to a 4.75% note simply to get someone off title is a hard pill to swallow,” says Guettler.
“However, regardless of the interest rate climate, it benefits both parties to consummate the divorce decree by refinancing. Refinances are structured to financially benefit the party who is retaining the property. And the party removed from title is no longer obligated to the mortgage on a property that they don’t reside in.”
What are the tax implications of a refinance in a divorce situation?
That’s why some couples don’t sell or refinance after splitting up, they both want to hang on to that tax shelter. But this decision can negatively impact your financial situation in the long term.
“In a divorce, the judge rules on how the property is to be dispositioned, but most of the time, the parties do not do what is ordered,” says Guettler. “So, both remain on title and are equally obligated on the loan. If one defaults, then it adversely affects both parties.”
If you’re the one moving out, you should insist that your spouse refinance the property as the sole owner, or they could default on the loan and hurt your chances to buy another house.
However, there are circumstances where hanging on to the house after a divorce is a good idea—at least for the short term.
“Even in a divorce situation, the federal government may consider it an investment property if you sell a home that you’ve owned for less than two years,” advises Shaw.
“Both parties may be responsible for 50% of the taxes on 50% of the profits from the home sale. So those tax implications, could influence your decision to either postpone your divorce to get past that two-year mark, or to sell the house after the divorce.”
If you do need to hang on to the house for a short period after the divorce is finalized, make sure to consult a tax professional. There’s a chance that the mortgage interest payment (if the home is owned by both of you) may be considered as alimony.
What happens if you’re underwater on your mortgage?
Not every divorcing couple has equity built up in their shared home. In some situations, they may actually owe more on their mortgage than the home is currently worth.
Is it still possible to refinance the property during a divorce if you’re underwater on the mortgage?
“Believe it or not, it’s easier to refinance or file a quitclaim to take one spouse off an underwater mortgage,” explains Shaw. “Since there’s no equity, the person staying in the home doesn’t need to relinquish any cash to do so.”
In fact, if there’s no financial benefit in refinancing for the spouse keeping the house—and there’s no equity in the home to split—you may still be able to remove one party from the deed without refinancing at all.
A quitclaim deed gives one spouse sole ownership of the property. However, the quitclaim does not remove that spouse from the mortgage.
However, they are under no obligation to do so. And some may refuse to release one spouse without a refinance simply to retain the option to attempt to collect from both parties in the event of a loan default.
So, if you file a quitclaim deed without removing yourself from the mortgage through refinancing, you may wind up responsible for the debt on a home you no longer own.
Plus, letting go of your half of an underwater home may or may not be in your best financial interest in the long run.
“There are pros and cons to relinquishing an underwater home. If the market comes back, which it typically does, you’ve relinquished any appreciation in that home that you once owned together,” explains Shaw.
“On the flip side, if you stay on that mortgage after a divorce situation, you’re still responsible to pay the debt on that house. And being on that mortgage may prevent you from buying another property because you’d have to qualify for both mortgages.”
What happens if I don’t qualify to refinance during my divorce?
When neither spouse can qualify to refinance the house during a divorce, then selling the home is probably the only option.
Since money is a sore spot for divorcing homeowners, selling the family home you once shared can become a major bone of contention.
Warring spouses battle over everything from setting the list price, to spending money on repairs or upgrades to prep the home to sell. The best way to avoid these confrontations is to hire a top-notch agent who has divorce sale experience.
Refinance or Sell? There’s no easy answer
Even when the split is amicable, divorce is difficult—especially when it comes time to deal with the home where you’ve raised your kids and made so many memories. Refinancing is a great way to keep the house in the family—if you can qualify for that new mortgage alone.
If you’re not financially able to refinance, selling allows both spouses to get a fresh start free from old mortgage debt. Just make sure you’re working with an experienced agent who knows how to make a divorce home sale run smoothly.