One of the biggest decisions divorcing couples face is what to do with their shared home. It’s often an emotional decision — and if the home has an outstanding mortgage, the situation gets extra complicated.
Here’s what to know about divorce and your mortgage.
Mortgage options in a divorce
Depending on the details of your mortgage, the circumstances of your divorce and other variables, you may have limited options for splitting your house. Here are some of the possible next steps:
1. Sell your home
The easiest option is often to sell the home and split the profits. Depending on where you are in the divorce process, you might agree to sell the home while the case is still pending rather than after it’s settled.
If you go this route — and many couples do — consider the costs. These might include the Realtor’s commission, the costs of repairs or staging, property transfer taxes and capital gains taxes. These expenses typically come out of the proceeds of the sale.
2. Refinance your mortgage
Some divorcing couples with a joint mortgage refinance to a new mortgage in only one person’s name. This releases the other person from responsibility for the mortgage. That person must also be removed from the house title, which you can do with a quitclaim deed.
Keep in mind: The party applying for the refinance can use only their own income and credit score to qualify, says Jeremy Runnels, CFP, of West Coast Financial in San Diego, Calif. “The lender is going to look at the individual and make sure they’re OK having them as the sole guarantor.” That could mean less advantageous terms — including a higher rate, given the state of current refinance rates.
But if the borrower will receive spousal support, they can use that income to qualify for a refinance as long as the divorce settlement stipulates that they will receive the support for at least three years, says Runnels.
3. Pay your ex for their share of equity
If you’ve built a substantial amount of equity in the home, the person keeping the house could apply for a cash-out refinance to buy out their ex-partner’s share.
The party keeping the home will still need to qualify for the refinance — and cash-out refinance rates may be higher than the rate on the original mortgage.
“Their income needs to be high enough to handle the new mortgage on their own, and the home must have the equity in it to take the cash out,” says Michael Becker, loan originator at Sierra Pacific Mortgage in Columbia, Maryland. “FHA and conventional cash-out refinances are capped at 80% loan-to-value, while you can go to 100% on a VA loan.”
If you want to keep the house and don’t have enough equity to do a cash-out refinance or the money to pay your ex their share, the solution might be a home equity line of credit (HELOC) or home equity loan. “Some lenders will allow you to go to 95 to 100% of the value of your home,” says Becker.
4. Other mortgage options after divorce
There are a few other mortgage options that may be worth considering amid a divorce.
For instance, it is possible to keep the mortgage as-is, but this approach can have drawbacks. Both individuals on the loan are still legally liable for mortgage payments, and if one person doesn’t pay, the other will be impacted. A divorce agreement should specify who is responsible for payments, but there’s a risk that one party may not follow such an agreement.
A mortgage assumption is another potential, but less common, approach. In an assumption, one mortgage holder transfers the loan to another person, who then pays the remaining balance at the mortgage’s existing loan terms and interest rate. Many mortgages don’t allow for assumptions, but it’s worth checking with your servicer. If it is an option, the process can also be used to formalize any changes in ownership of the home.
Divorce and mortgage considerations
Before choosing a course of action, consider the long-term impact on your finances. You may ask a financial advisor to help you weigh the pros and cons.
Evaluating your home value and equity
Whether you plan to refinance the joint mortgage or sell the home, you’ll need a professional appraisal to determine its worth — and the equity stake the parties have to split.
However, if a former couple doesn’t agree on the results of an appraisal, this can cripple efforts to move forward. Parties should strive to agree on an appraiser and to accept the outcome of the valuation, whatever it might be. (Likewise, if you decide to sell the home, you might include a provision in the separation agreement that you’ll accept the first offer on a home, provided it’s within a certain percentage of the list price.)
Remember that your home value — and thus, your equity — can affect the options for your mortgage. If you don’t have very much equity, you’ll have a more difficult time qualifying for a refinance, for example.
Tax implications
Whether you sell the home as part of the divorce agreement or buy out your spouse’s share, capital gains taxes could come into play. This is a tax on the sale of assets, such as a home, when the profit exceeds a certain amount.
If you sell the home, you and your spouse might be able to deduct up to $250,000 of gain each from your federal taxable income, but it applies only to the primary residence you’ve lived in for at least two of the last five years before the sale.
There are also tax considerations regarding spousal support payments. The spouse who earns a higher income and pays spousal support can’t deduct those payments from their taxable income, but the spouse receiving the support does not have to declare it as income.
The higher-earning spouse could make a case for paying less spousal support, which can lower the receiving spouse’s income to qualify for a new loan, says Runnels.
Conversely, spousal support payments might hurt the payer’s income and chances for a mortgage.
Protecting your credit
Divorce is an emotional, often volatile event — but the worst thing divorcing couples can do is take financial revenge.
“Many times, out of bitterness, I’ve seen one or both spouses ruin the credit of the other spouse,” says Becker. “They decide that it’s the other person’s problem and refuse to pay bills on joint accounts. This can damage your credit greatly and keep you from being able to qualify for any mortgage for a long time.”
The bottom line: Keep paying all of your bills through the divorce process to protect your credit. “Close your joint accounts and get your own accounts set up,” says Runnels. “If you’re arguing with your spouse over who is going to pay a bill, and you get a ding on your credit, it’s going to be harder to get a loan.”
Key takeaways
•If you obtained a joint mortgage with your ex, you’re both responsible for the debt, even after divorce.
•Divorcing couples with a joint mortgage typically sell the home, refinance the mortgage in one spouse’s name or have one party buy out the other.
•Your divorce agreement should cover all possible scenarios to protect both parties from financial harm.
Additional reporting by Erik Martin