Divorce and mortgage: What are your options?

How to choose the best divorce mortgage strategy for you

Divorce and mortgage considerations often add complexity to an already challenging process. With a joint home loan in the mix, navigating a divorce requires careful planning.

Yet, proven divorce mortgage strategies can assist both parties. These strategies vary, depending on the home’s equity, the purchase and title details, and if one spouse intends to retain ownership.

Despite the intricacies, the right approach can resolve nearly any scenario involving a mortgage during a divorce.

In this article (Skip to…)

• Divorce mortgage options
• Refinance or sell?
• Divorce and mortgage concerns
• FAQ

>Related: Cash-out refinance: Best uses for your home equity

What are your divorce mortgage options?

In a divorce, who gets the house is a major decision that often depends on the divorce and mortgage details. If your name isn’t on the mortgage, understanding your rights is essential. It’s also important to understand how divorce affects your home loan and mortgage responsibilities.

1. Refinancing a mortgage after divorce

During a divorce and mortgage, refinancing the existing mortgage to have only one spouse’s name is often the cleanest solution in a divorce.

After the mortgage refinance closes, only the person named on the mortgage would be responsible for making the monthly payments. The person no longer named on the mortgage could then be removed from the home’s title.

• Example: let’s say John and Jennifer jointly own a home valued at $300,000 with a remaining mortgage balance of $200,000. They decide Jennifer will keep the house. Jennifer could refinance the mortgage into her name alone for $250,000. She’d use $200,000 to pay off the original joint mortgage, then pay John the remaining $50,000 for his share of the equity.

If necessary, a cash-out refinance could pay the portion of equity that is due the departing spouse. Refinancing into a new mortgage could be the simplest solution, but it works only when one spouse can qualify for the loan on their own. Mortgage eligibility will depend on these factors.

Borrower’s income

A single borrower often earns less than a couple, making it harder to qualify for a mortgage individually. During the underwriting process, the lender will verify the single borrower’s income and compare it to their monthly debts, including credit card minimum payments and car payments. If the single borrower’s income can support the new loan’s mortgage payment, then refinancing is a viable option.

Borrower’s credit score

The person refinancing the mortgage loan must have a high enough credit score to qualify. If your credit scores have fallen since you took out the current mortgage loan, you may no longer qualify for a refinance. Certain loan programs like FHA, VA, and USDA loans have more lenient credit score requirements, typically allowing scores as low as 580 in some cases.

You may be able to improve your credit with a rapid rescore, but rebuilding credit is often the only solution for a low credit score, which can take months or years.

Borrower’s home equity

Limited equity from a recent purchase, small down payment, or second mortgage can hinder refinancing. Conventional loans typically require at least 3% home equity, while FHA and VA loans allow refinancing with little to no equity in some cases. Lenders may call this your loan-to-value ratio, or LTV. A home with 3% equity would have an LTV of 97%.

2. Refinancing with low home equity

Certain refinance options allow you to remove a spouse’s name from the original mortgage, despite a home’s low equity position.

FHA Streamline Refinance

If you already have an FHA loan on the home, you can use the FHA Streamline Refinance to remove a borrower without checking home equity. However, the remaining spouse must show that they have been making the entire mortgage payment for the past six months.

A Streamline Refinance is best for those who have been separated for at least six months. But it is not ideal if your settlement agreement requires you to resolve your divorce and mortgage situation right away.

• Example: Pat and Mary’s divorce has been finalized, but their home has seen better days. With only 2% equity, refinancing seems impossible. But wait! They have an existing FHA loan. By using an FHA Streamline Refinance, Mary, who’s keeping the house, can remove Pat from the mortgage without worrying about the low equity. Game on!

VA Streamline Refinance

VA loan holders can use a VA Streamline Refinance to remove a spouse’s name from their current VA mortgage after a divorce. Typically, the spouse who is a veteran must remain on the home loan.

Only military personnel and veterans can use VA loans. So if the departing individual is the veteran, the remaining spouse would have to refinance into another loan type.

If the remaining spouse is eligible for a VA loan, they may also opt for a VA cash-out loan. This option allows homeowners to take out a new loan amount of up to 100% of their home’s current value. This feature could enable the remaining spouse to pay out the departing partner’s equity in the home according to the divorce and mortgage decree.

• Example: After 10 years of marriage and one deployment, Sarah and David are calling it quits. David, the veteran, wants to keep their home but it has almost no equity. His secret strategy? A VA Streamline Refinance. This allows him to refinance into his name only, even with little to no equity. With a VA loan, he’s got a chance of keeping his home post-divorce.

USDA Streamline Refinance

Loans backed by the U.S. Department of Agriculture, known as USDA loans, can also qualify for Streamline Refinancing. Just like VA and FHA loans, a USDA Streamline Refi works only if you already have a USDA loan. USDA loans work in rural and suburban areas and only for borrowers who fall within income limits.

Conventional refinance

Conventional loans do not offer a Streamline Refinance option. However, it’s still possible to refinance a conventional loan with low home equity. Fannie Mae and Freddie Mac — the two agencies that regulate most conventional loans — only require 3% equity in the home to refinance. That means your LTV must be 97% or lower.

Lender requirements may be stricter than Fannie and Freddie’s minimums. Shopping around is essential if you have low equity.

3. Buy out your ex-spouse’s share of the home equity

In many states, courts will split the built-up equity in a home between the two divorcing partners. If you’re keeping the home and you don’t have enough cash to buy out your ex-spouse’s share, you’ll need to use the home’s equity for a “divorce and mortgage” buyout agreement.

A home equity loan or HELOC could access your equity without refinancing the first mortgage. So, if you got a great interest rate during the pandemic, you could keep it.

You’d keep making your current mortgage payment and you’d add a second monthly payment to pay off the home equity loan. Closing costs are low and these loans are faster and easier to get than a primary mortgage.

• Example: Imagine your home is worth $400,000 and you still owe $250,000 on the mortgage. That leaves $150,000 in equity. If you need to pay your ex-spouse $75,000 for their share but don’t have the cash, you could take out a home equity loan for that amount. You’d continue paying your existing $250,000 mortgage along with the new $75,000 home equity loan.

4. Selling the marital home during divorce

Selling the home lets divorcing couples split the profits and go their separate ways. Determining who pays the mortgage until the sale closes is a short-term challenge. But selling often means both spouses moving and ending a real estate investment, with potential losses in a cooler market.

Equity is also important when selling. It typically costs between 7% to 10% of the value of your home to sell. This total consists of agent fees, taxes, title insurance, and other closing costs.

Example:

• If your home is worth $300,000 and you owe $250,000, selling would leave you with about $30,000 in profit after a 6% agent commission of $18,000 and around $2,000 in other closing costs. If you need to make repairs or offer concessions to the buyer, that could further eat into your profits.

If selling or refinancing isn’t feasible, keeping the home and mortgage is an option, but a risky one.

5. Keeping the marital home and mortgage after divorce

If selling or refinancing the marital home isn’t feasible or desirable, keeping the existing mortgage is an option. But it’s risky, as both parties remain liable for the payments. The divorce agreement must specify who will make the payments. The spouse keeping the house might pay, or the divorce settlement could split the payment.

Risk to future home loan eligibility

Keep in mind that leaving your ex’s name on the mortgage post-divorce may impact their ability to buy a new home in the future.

A borrower’s debt-to-income ratio (DTI) is crucial when qualifying for a new mortgage. When a potential home buyer is listed on another mortgage, that debt appears in their DTI and could affect the new loan application — even if they aren’t actually making payments on the existing mortgage.

Risk of missed payments

This situation can also lead to missed mortgage payments if your former partner won’t or can’t abide by the divorce decree. In a dire divorce and mortgage situation, you could lose the home and its value to foreclosure.

• Example: Say your former spouse is supposed to pay the mortgage each month, but your name remains on the loan. If your former partner misses a payment, your three-digit FICO score on your credit report could fall by as much as 100 points.

Both partners are still jointly liable

Remember that when your name remains on the loan, your mortgage lender considers you equally responsible for making the payments each month. Your mortgage holder will not dismiss late payments, even when your divorce attorney has negotiated your ex-spouse’s responsibility in the settlement agreement.

Example:

• Let’s say you and your ex-spouse agree that they will keep the house and continue making the $1,500 monthly mortgage payments. But months later, they lose their job and fail to pay the mortgage. Even if the divorce decree assigned the mortgage to your ex, the lender will still come after you for the missed payments. Your credit could be severely damaged, and you could even face foreclosure.

For this reason, a shared mortgage after a divorce might only work well in amicable divorces.

What happens if I can’t refinance my mortgage after a divorce?

If you can’t qualify for a refinance or don’t like the rates, selling the home or buying out your ex’s equity are alternatives. Carefully assess each option’s financial impact and alignment with your divorce agreement.

Should you refinance or sell your home during a divorce?

Selling or refinancing are often the safest options in a divorce. While a divorce agreement might specify mortgage payment responsibilities, an ex-spouse’s actions can still damage your finances if you keep a shared loan.

A divorce settlement might state your ex will refinance by a set date, with the stipulation to sell if the refinance doesn’t happen. This protects the departing spouse.

Divorce and mortgage: Key financial concerns

When you’re untangling your life from your spouse’s, understanding the financial implications for handling your mortgage during a divorce is important. It’s not just about splitting assets; it’s also about securing your personal finances.

Here are a few steps you can take to protect yourself financially when dealing with a divorce and mortgage.

Determine your home equity in a divorce

If you’re looking to either refinance your joint mortgage or put your house on the market, get a professional appraisal to establish exactly how much equity you have. This can give you a clear starting point for negotiations.

Appraisal disagreements can stall the process and increase legal fees. Agreeing on one appraiser and their valuation is practical.

In the case of a home sale, you may choose to divide the equity after deducting closing costs, home repairs, and improvements, or you might opt to use it to clear joint debts. Some separating couples agree upfront to accept an initial offer on their property, as long as it falls within a specified range of the asking price.

Protect your credit history during divorce proceedings

Divorce and mortgages can be emotionally charged, and letting those feelings influence financial decisions can lead to detrimental outcomes. Sometimes, spouses may intentionally skip payments on joint accounts out of spite, which can severely damage both parties’ credit scores and hinder their ability to get a mortgage in the future.

Keeping up with all bills during the divorce is crucial to safeguard your credit.

Example:

• If you have a joint credit card with a $5,000 balance, work out an agreement on how to pay it off. You might each transfer half the balance to individual cards, or one person might agree to pay the full amount if the other person takes on a different debt.

Close joint accounts and open individual ones to prevent payment disputes that could hurt your credit.

Tax implications of divorce and mortgage

Selling your home during a divorce or purchasing your spouse’s share might trigger capital gains tax if the profit exceeds the exempted amount. This tax applies to profits from selling assets like a house.

When you sell, you and your spouse could deduct up to $250,000 each from your taxable income, provided the home was your primary residence and you lived there for at least two out of the last five years before selling.

Example:

• If you sell your marital home for $500,000 and you originally bought it for $300,000, you’d have a $200,000 profit. If you and your ex-spouse each qualify for the $250,000 exclusion, you could both exempt your $100,000 share of the gain and owe no capital gains tax.

Regarding alimony, post-2018 divorce agreements stipulate that the higher-income spouse who pays alimony cannot deduct it from their taxable income, and the recipient does not have to report it as income.

This could prompt the higher-earning spouse to argue for lower alimony since it affects both the payer’s ability to secure a mortgage and the recipient’s capacity to afford the home and its associated costs.

*Please note that this information is not intended as tax advice, and you should consult a tax professional for guidance on specific situations.

FAQ: Divorce and mortgage options

What are current refinance rates?

The bottom line: Divorce doesn’t mean giving up on homeownership. Refinancing is a common way to remove an ex from the mortgage and potentially pay their share of the equity. Mortgage rates will depend on your credit and loan terms.

It’s wise to seek a mortgage pre-approval to understand the refinance rates and deals available for your divorce mortgage situation. You can get started today by clicking on the links below.