One of the biggest financial issues you’ll face in a divorce is what to do with the family home. For many people, it’s the largest asset they have accumulated in their marriages, and it can be a source of several disagreements when a couple splits.
If you or your spouse wants to keep the house, you’ll need to figure out how to handle the mortgage.
In fact, one of the questions clients ask me all the time is: “Should I refinance after divorce”?
Here are 6 important reasons to consider refinancing the mortgage following your divorce–and options for what to do if you can’t qualify.
Let’s jump in.
Reasons to Refinance After Divorce
1. Remove your spouse from the mortgage loan
The first thing to know is if you’re keeping the house, you will typically be required to refinance the mortgage as part of the divorce settlement.
If part of the reason you got a divorce is that there were money issues in your marriage, then a driving factor for protecting your credit will be to remove your spouse from the loan, assuming you want to keep the family home.
Removing your spouse from the mortgage can be challenging because you’ll need to requalify on your own. If you and your spouse both contributed financially to house payments before, you could be in for a bad surprise unless you are a high income wage earner.
When you take on a mortgage by yourself, you’ll need to show proof of income, proof of insurance, proof of debts and assets, and your current credit score.
Essentially, you both remain liable for the mortgage unless you sell the home, pay off the home or you or your spouse refinances the home to remove your name. Until that time, if either spouse misses a payment, both parties will take a hit to their credit. The lender does not care about your divorce. They only care about being paid by the people who agreed to do so when the mortgage was agreed upon.
Another thing to note is that many people mistakenly believe that removing a spouse from the title to the house is the same as coming off the mortgage. That’s not the case. They are two separate transactions.
When you’re crafting a settlement agreement, it should include provisions that the spouse keeping the house will refinance shortly after the divorce, and that the out spouse will be removed from the title shortly thereafter as well. To protect your interests, it’s wise to build in provisions to address what happens in the event a spouse does not follow through.
Keep in mind that in addition to refinancing on your own, you’ll also need to compensate your spouse for their share of the interest in the home. You may be able to trade off other marital assets, such as a pension, or refinance in such a way that you can take additional funds to buy out their share of the home.
2. Buy out your spouse
For many married couples, a home is the most valuable asset they own. That means, when you get a divorce, it will be the most valuable asset you’ll have to divide.
If you decide one of you wants to keep the house, then the spouse who keeps the house will need to find a way to compensate the spouse who releases their interest. There are a couple of ways to do this.
You can “buyout” your spouse by trading another marital asset of equal value. This might mean cash assets in bank accounts, or assets in retirement and pension plans.
Another way to compromise on a buyout is to forego spousal support if you’re keeping the house and your spouse would otherwise need to pay you. This type of transaction can be complicated, and it’s best to work with a Certified Divorce Financial Analyst to make sure this is a prudent financial decision for your circumstances.
You can also buy out your spouse through a cash-out refinance. Using this strategy, you would tap into the equity in your home by taking out a bigger mortgage than your current existing mortgage. That additional money would be used to buy out the other spouse’s interest in the home.
Unless you are rock solid financially, this could be a risky proposition because not only are you going to have to cover your new mortgage payment on your own, you’ll also need to cover a larger payment because you’re refinancing a larger amount.
Things can also get more complicated if the home is not equally owned by both parties. One spouse may have owned the house before marriage and is entitled to a larger share of the equity, or a prenuptial agreement might be in place that could also spell out different terms.
3. Cash-out your home equity for other reasons
Cash-out refinance proceeds can be used for other purposes as well.
Home prices have soared in recent years, and in some cases, that has left couples house rich and cash poor. With interest rates at historic lows, a cash-out refinance can also become a source of low-cost, liquid capital.
In a divorce, your finances are going to be jumbled for a while. You’ll need to learn how to live on a single income, your expenses will be different, and you may have existing debts that could be hanging over your head.
A cash-out refinance can help you with a new start by paying off credit card balances, medical bills, legal bills, HELOCs and other loans, and helping you to establish an emergency cash reserve fund.
If you’re planning on staying in the home, then a cash-out refinance can also be used for home improvements so that you can protect your investment over the long-term.
Some people take cash-out funds and put that money to work in other investments. The thought here is to find an investment with a higher rate of return than the interest rate on the mortgage loan, generating a net positive amount.
4. Lock in a fixed-rate loan
About 10% of home buyers take out loans with adjustable-rate mortgages (ARMs). With an ARM, the rate and the payments are fixed for a certain period of time (usually 5 or 7 years).
However, once that term expires, the payments can either move up or down based on prevailing interest rates according to a preset formula. The interest rate reset based on a benchmark or index, plus an additional spread, called an ARM margin. The rate adjusts annually in subsequent years using that same formula.
In most cases, ARMs are tied to one of three indexes: the maturity yield on one-year Treasury bills, the 11th District cost of funds index, or the London Interbank Offered Rate.
Some people choose to go this route because the low initial costs of ARMs are attractive and can save money at a time when a family is starting out. But this strategy can backfire if interest rates jump up, leaving the borrower with a much bigger payment than they anticipated. This can be a jolt even though ARMs come with rate caps that limit how high the rate can be or how drastically the payments can change.
At a time in your life when divorce brings so many financial and emotional variables into play, refinancing to lock in a fixed rate on a loan is one less thing to worry about as you rebuild your life.
Being able to set a budget and determine an accurate post-divorce cash flow is crucial to making sure you don’t get in over your head, putting your ownership in jeopardy.
If an ARM still seems like an attractive alternative to keep costs low, refinancing an ARM that extends the fixed period further in the future could be a stabilizing strategy to explore.
5. Reduce your interest rate
Mortgage rates are always in a state of flux. More than likely, there’s a good chance the rate you got when you first took out your mortgage is different than the rate you might be able to qualify for now.
Also, you may qualify for a different interest rate because of your loan type and choice of lender.
Like any other big purchase, you need to do your homework and shop around for the best interest rate that you can get.
Even if rates are not as competitive as what you had hoped, this shouldn’t be a reason to not refinance your home. If rates have increased since you bought your home, it could be a limiting factor for you, and may mean the difference as to whether you can keep your home or not.
But if you can afford it, putting off refinancing because of interest rates is a mistake according to many experts. It may be difficult to accept if you have to pay an added point just to take sole control of your mortgage.
Although it will cost more, refinancing to retain a property still carries a lot of benefits with it as opposed to refinancing the property or settling for something less.
6. Lower your monthly mortgage payment
Interest rates have come down dramatically since the recession of 2008. They are now at near historic lows. If you haven’t refinanced in the last few years, chances are you may be able to lower your payment.
It’s also possible, by selling other assets such as gold, jewelry, art, collectibles and other valuable property, that you may have a large amount of cash on hand. In addition to enjoying a more favorable interest rate, you could pay down some of the outstanding balance when you refinance and leave yourself with an even lower monthly payment.
Your best bet is to check with your mortgage professional to explore creative options that fit with your current situation and goals. You might be surprised at the kinds of opportunities you can enjoy when recalibrating your post-divorce finances.
Why you may not qualify to refi
You’re going to be facing several challenges that could prevent you from refinancing your home after a divorce.
We’ve already mentioned that you could be strapped for cash because you’ll need to offer up some form of buyout to your spouse for the portion of the house equity they’re entitled to receive. That can completely suck away a lot of the financial flexibility you’ll need.
When you refinance, you’ll also need to qualify based on your own income. That’s much easier if you’ve been a breadwinner during the course of your marriage. But if you’ve been a stay-at-home spouse, you are going to have a rough go of convincing a lender that you’re a worthy risk.
If you still owe a lot on the house as a couple, you’ve got to figure out a way to refinance that amount with only your income as well. Even if you have a good job, if it took both incomes to make ends meet, then you may not qualify for a large enough amount to make the new mortgage work. If you owe $1 million, but can only qualify for a $500,000 loan, you have an obvious gap working against you.
The other thing a divorce can do is cause havoc on your credit. You may have had spotless credit for many years, but if one spouse takes a walk on obligations, it will kill both spouse’s credit scores, probably for a long time to come. Lenders don’t care if one spouse or the other wrecked your score. They only care that you found a way to meet your financial agreements, no matter what the situation.
Options if You’re Unable to Refinance During or After Divorce
If you can’t qualify to refi on your own, then there are a couple of options to explore.
Find a cosigner
The bank of “mom and dad” has no statute of limitations, no matter how old you are. But entering into a cosignatory agreement should not be taken lightly. Friends and siblings may also be a willing source of help. But the best intentions can come at a price.
You could be jumping out of the frying pan and into the financial fires of hell if you don’t approach a cosigner obligation the right way. Cosigners are just as obligated to make house payments or repay the debt in full to avoid foreclosure. Otherwise they run the risk of comitted financial suicide as well. Lenders do have the legal right to seek payments from the cosigner.
Cosigners are subject to meeting all the requirements for a loan, just like you are. A lender will look at their assets, obligations, credit score, credit history, debt ratios and other factors as part of the decision-making process.
The primary difference with a cosigner is that they typically don’t have ownership rights in the property. They are used as guarantors to ensure the loan is repaid.
Convince your spouse not to require you to refinance
The second option is to ask your spouse not to require you to refinance. Since your spouse will still be on the mortgage, their credit is at risk if your miss payments. You might have to sweeten the pot by giving your spouse something else they want in return for agreeing to remain on the joint mortgage.
Keep in mind that this is only an option if you don’t need to pull cash out of the house.
Alternatives to refinancing the home
If you have challenges while attempting to refinance your home through a mortgage lender, there may be some other options you can explore.
Home Equity Line of Credit
When you have a good amount of equity built up in your home, a home equity line of credit (HELOC) can be a solution you can tap into. You won’t refinance the first mortgage. Instead, you’ll simply add a second mortgage to your existing loan. Closing costs are low and the turn-around time for approval is quicker and easier to get than with a traditional refinancing scenario.
Instead of a loan refinance, you may be able to assume the home loan instead. You would need to have an existing mortgage that allows for this option. There’s a common misconception that all loans are assumable. That’s definitely not the case. You can easily determine whether a loan is assumable by looking at the original promissory note.
Assuming a loan makes great sense when you have good rate and payment terms on your existing mortgage. Fees are typically less (often less than $1,000), but you will need to go through a qualification process including providing information about your income, assets and other related information. The burden still rests on you to prove you can handle the assumption on your own.
One drawback for loan assumptions is that they can take as long as six months to complete. Refinances are typically completed in 30-60 days. It can be devastating to learn you don’t qualify for an assumable loan after waiting up to 180 days for a lender to review your request.
If you have little or no equity in your home, you may be able to secure a personal loan for up to as much as $100,000. Approval takes place within a matter of days most times. In this case, the home is put up as collateral, but it does give you additional financial flexibility to resolve buying out your spouse. Approval depends on your past credit history and your current income.
The FHA offers a streamline refinance option under certain conditions. If you purchased or last refinanced your home with an FHA loan, you are allowed to refinance to remove a borrower from the loan. However, the remaining spouse must show they have been making full mortgage payments on their own for the past six months. This works best for spouses who have been separated for at least that long.
The VA also offers a similar streamline refinance option as well. A spouse can be removed from the loan, but the veteran is the one who must remain on the loan in most cases. But if the remaining spouse is eligible for a VA loan, he or she can opt for a VA cash-out loa. This makes it possible to pay out the partner’s equity in the home.
Private money loans, made through “hard money lenders” can also provide a source for refinancing. These bridge loans are usually made with higher interest rates in the short-term and funded by private lenders or investment groups.
Homeowners put up their equity in their home as collateral as opposed to relying on their credit worthiness. Borrowers with poor credit or who are otherwise financially strapped sometimes tap into this alternative. But money is usually available in just a few days after you apply.
Selling the home as a last resort
Unfortunately, no matter how creative or financially savvy you are, in many cases, the argument for keeping the family house simply doesn’t pencil out.
If you’re emotionally tied into the house because of a lot of great memories, or you were trying to keep the house because you want to continue to provide stability for young children still at home, this can feel devastating.
If none of the above are workable, then you may have to consider selling the home. In some ways, this provides more of a clean break emotionally and financially.
But selling the home does come with it’s own set of challenges. You’ll need to work together to decide what realtor to work with, determine the list price, and agree on how much to spend to ready the house for sale.
As difficult as it may be, you’ll need to compromise to get this kind of a deal done so that you can move on with your life.
Depending on your relationship with your spouse, including the all important level of trust, you may be able to negotiate a delayed sale of the home.
If the real estate market in your area is weak, or if both of you agree that providing stability for your children is critical, then you may be able to agree to sell the home later.
You will need to work out an agreement on who makes mortgage payments, handles upkeep and which expenses are covered vs those that are not. But this can be a workable solution if you are at least on civil terms with your significant other.
You’ll also need to work out the terms of who gets what when you ultimately do sell. This is part of the larger picture of your overall divorce settlement. You may agree to take less from a pension in exchange for a larger share of the net proceeds from a home sale at a later date. Or, if you’re strapped for cash, you may give up a larger share later in exchange for more financial security now.
The key here is to make sure your agreement is very specific to avoid even more arguing at a later date. That means figuring out expenses, broker’s fees, taxes, maintenance, and home prepping for sale expenses are determined.
This article expands on Jason’s article which was originally published on Forbes here.