Considerations for Retaining the Marital Home After a Divorce

WHAT IS THE VALUE OF THE MARITAL HOME?

For many married couples, their home is often their most significant investment, and it represents a substantial portion of their net worth. More specifically, the equity in their home represents a substantial portion of their net worth. The equity in your home is derived by taking the value of your home and subtracting any mortgages on the property. For example, if your home is valued at $550,000 and you have a $200,000 mortgage and a $50,000 home equity line, you would take a $550,000 valuation and subtract both loans (200,000 +50,000) totaling $250,000 leaving you with $300,000 in equity. The outstanding loan balances are easily obtained by reviewing your monthly loan statements, but where do you obtain the valuation on your property?

You can obtain the value of your home in multiple ways. You may have a Comparative Market Analysis (CMA) done, which is usually performed by a Real Estate Agent when deciding what price to list a house for sale. A CMA usually involves evaluating recent sales in the area that are similar to the subject property. There is also an Automated Valuation Model (AVM) which is an algorithmic analysis based on sales data of comparable homes in the area (Think Zestimate). The AVM is done without a visual inspection of the property, so it may lack the thoroughness of a full appraisal, which can bring the appraisal value in a touch lower. Another possibility is to obtain a Qualified Appraisal by a licensed appraiser. This is a full boots-on-the-ground inspection of the home, both inside and out. The appraiser would then derive the value of the home by using recent comparable home sales, in the surrounding area, with similar attributes to the subject property. If the plan is to sell the home during the divorce process the valuation is more about getting an estimate for total proceeds that will be split during the divorce. In this instance a CMA would suffice, though I have been told that courts are steering away from CMAs. If the house will ultimately be sold, approach the process with an open mind on the valuation range. The house could sell for more in a hot real estate market, and it could sell for less in a softer market. Be reasonable in your expectations and avoid making a problem out of something that is not even necessary. If one spouse is considering keeping the home, a certified appraisal is usually the best choice. Be aware that an appraisal done for a divorce is different from an appraisal done for a lending institution. The first one seeks a general valuation, while the second (URAR 1004) is required by government agencies when lending on a property for a qualified mortgage.

Another important thing to consider is that, when doing an equity buyout subject to divorce, the lending institution will only lend based on the appraisal that they receive as part of the application process. Any independent appraisal you may have had done, cannot be used. If the bank's appraisal comes in different from any other appraisal performed, there must be a contingent plan to account for the difference.

YOU DECIDED YOU WANT TO BUY IT; NOW LET'S LOOK AT THE NUMBERS

Income When aiming to keep the marital home after divorce, it is vital to assess the individual’s "Qualifying Income.” Just because you are receiving income from a source does not mean it will be used as qualifying income on a mortgage loan application. It must meet lender and lending agency guidelines. Consult a Certified Divorce Lending Professional to review your income sources. Adequate income is necessary to cover mortgage payments, property taxes, hazard insurance, and other homeownership costs. A careful evaluation of current income sources, such as employment, investments, retirement and potential alimony or child support, should be undertaken to ensure ongoing financial stability. Certain kinds of income are not subject to taxes. For example, support payments, social security, and disability payments are considered by lenders to be more valuable. Usually, non-taxable income is worth between 15- 25% more for mortgage qualifying income (depending on which agency guidelines you are following). So, $2,000 a month in spousal support could count as much as $2,500 in qualified income per month. This practice is referred to as “grossing up” income because you will have more after tax income. For this type of income to be considered as qualifying income it must be received for 6 months and will continue to be received for 36 months following the funding of the mortgage. Additionally, there are methods to use asset equalization payments, sometime required because of divorce, to create additional income streams. It can be more advantageous for a borrower to receive a consistent payment stream as opposed to a lump sum payment. This can be accomplished by setting up a revokable trust that makes consistent payments over the required amount of time.

Liabilities Divorcing homeowners must consider their existing liabilities and how they will affect their borrowing ratios. This includes outstanding debts, such as credit card balances, student loans, and car loans, along with any future financial obligations like child support and alimony. History of repayment is an important consideration. The ATR Rule (Ability to Repay) was implemented by the Dodd Frank Act of 2013 in response to the 2008 financial crisis. According to this regulation, “creditors shall make a reasonable and good faith determination of a consumer's ability to repay any consumer credit transaction secured by a dwelling.” Your ability to borrow money will be hurt by missed or late payments as well as past collection accounts. An accurate assessment of liabilities helps determine the available resources for a mortgage payment and maintaining the home. Another important factor to keep in mind is that all co-signed debts will also appear as full liabilities on your credit report. It is crucial to specify in your separation agreement or divorce decree which liabilities will fall under your responsibility and which ones will be the responsibility of your ex-spouse. Additionally, any additional support payments required by the payee in the divorce decree will be considered as a liability on a mortgage application.

Credit Score A divorcing homeowner's credit score plays a significant role in securing favorable mortgage terms and interest rates. A lower credit score may result in higher interest rates or even difficulty in obtaining a mortgage. Regularly monitoring and improving one's credit score before attempting to retain the marital home is advisable. If divorcing couples have joint accounts or shared liabilities, such as joint credit cards, mortgages, or loans, any missed or late payments by either party can negatively impact both individuals' credit scores. It is crucial to communicate and establish clear responsibilities for these shared accounts during the divorce process to minimize the potential negative impact. For individuals who experience negative impacts on their credit scores during divorce, rebuilding credit becomes a priority. This involves making timely payments, reducing debt, and establishing a positive credit history. Responsible credit management, such as keeping credit utilization low and diversifying credit accounts, can help improve credit scores over time.

Debt-to-Income Ratio The debt-to-income (DTI) ratio measures an individual's ability to manage existing debts relative to their income. Lenders often consider this ratio when evaluating mortgage applications. A divorcing homeowner seeking to retain the marital home should calculate their DTI ratio, aiming for a ratio that falls within the acceptable range determined by lender. There are two DTI ratios that lenders consider when evaluating a borrower: front end DTI and back-end DTI. The front-end DTI ratio measures the proportion of a borrower's gross monthly income that is allocated to housing-related expenses. This includes mortgage principal and interest payments, property taxes, homeowners' insurance, and HOA fees and mortgage insurance (if applicable). The back-end DTI ratio considers the total debt obligations of an individual relative to their gross monthly income. It includes housing-related expenses (as calculated in the front-end DTI ratio) along with other monthly debts such as credit card payments, car loans, student loans, and other outstanding loans or debt obligations.

PERFORMING AN EQUITY BUYOUT

When one spouse wishes to keep the marital home, an equity buyout may be necessary. The equity buyout, as an event of divorce, is the process of one spouse acquiring the equity ownership in the marital home from the other spouse. It is usually accomplished by a refinance of the existing mortgage. The departing spouse receives their share of the equity in the marital home and releases their ownership in the property by a quitclaim deed or other conveyance of ownership. The terms of the buyout should be spelled out in detail in your separation agreement and/or divorce decree. This document may be requested by your lender during the application process. Determining the buyout amount involves assessing the current fair market value of the property as described in the valuation section. It is crucial to consult with a professional, such as a real estate appraiser, to determine an accurate buyout amount. Another important thing to consider is that, when doing an equity buyout subject to divorce, you may only refinance the current loan balance and any portion of the departing spouse’s equity not a penny more. If you try to take out additional funds it will be deemed a cash out refinance and be subject to higher rates and fees. Remember that you will most likely be financing the existing mortgage balance along with the exiting spouse’s equity portion, so depending on how long you have had your current mortgage, there is a high probability (especially in today’s interest rate environment) that your monthly mortgage payment will significantly increase.

ALTERNATIVE WAYS TO REFINANCE YOUR HOME

There are other financing options available that can aid in the process of retaining the marital home during a divorce. These techniques offer alternatives to conventional mortgage financing and can be especially helpful in circumstances where the separating spouse may have trouble satisfying the requirements of the usual lending criteria. Co-signers, asset depletion loans, home equity lines of credit (HELOCs), as well as the possibility of assuming your current mortgage, are some of the alternative financing strategies to take into consideration.

In situations where the retaining spouse may not meet the income or credit requirements to secure a loan independently, involving a co-signer can be a viable option. A co-signer, typically a trusted family member or friend, agrees to assume responsibility for the loan if the retaining spouse defaults. The co-signer's income, creditworthiness, and assets are taken into consideration during the loan approval process, providing additional support and improving the chances of loan approval.

Asset depletion loans are designed to consider the borrower's overall asset portfolio, including investments, savings, and other valuable assets, rather than relying solely on income and creditworthiness. With an asset depletion loan, the lender takes into account the value of the borrower's assets and uses a calculation to determine the monthly income that can be generated from those assets. This calculated income is then used to qualify the borrower for the loan. This approach is particularly beneficial for individuals with significant assets but limited income or unconventional income sources. It is important to note that asset depletion loans typically involve a thorough assessment of the borrower's asset portfolio, including its liquidity, stability, and potential risks. Lenders may require detailed documentation and verification of the assets and may impose certain restrictions or requirements.

A (HELOC) or home equity line of credit allows homeowners to access the equity they have in their home. HELOCs provide a revolving line of credit that can be used for various purposes, including financing the buyout of the marital home during a divorce. The amount that can be borrowed is typically based on a percentage of the home's appraised value less any outstanding first liens. HELOCs supply flexibility, allowing homeowners to borrow only what they need when they need it, and to make interest-only payments during the draw period. The main drawbacks of using a HELOC is that lenders usually take a haircut on the appraisal because it is performed through an algorithm and the LTV for borrowing with a HELOC is usually lower (75%). These two factors can limit the equity available to pull out of the transaction.

In some cases, a divorcing homeowner may be eligible to assume the existing mortgage without refinancing. Mortgage assumption transfers the responsibility for the mortgage payments to the retaining spouse. If this option is available, it is typically specified in your original loan documentation. This option usually requires other fees and the lender's approval. Loan assumption typically involves meeting specific criteria, such as creditworthiness and qualified income verification. Additionally, you will still need to consider another way to give the exiting spouse their share of the equity in the home as a mortgage assumption does not allow you to take out equity in the transaction.