Breaking Your Mortgage Vows: Homes Loans and Divorce

Sell Up

Selling the house gets you a clean break, and the joint mortgage obligation disappears. In addition, the proceeds of the home can be used to dissolve other marital debts, releasing both parties.

However, this option may have some deal-breaking drawbacks. Remaining in the same home and school district may be essential for your children. The sale proceeds might not be sufficient to pay off the mortgage, or the tax consequences might be too costly. If selling the property is not feasible, a new mortgage may provide your way out.

Move Out

Many divorcing couples choose to transfer the property to one former spouse. The occupying ex may take over the existing mortgage, refinance the loan into his or her name, or ask the lender to drop the non-occupying spouse from the mortgage.

You might believe that if a divorce decree makes only one spouse responsible for the mortgage payment, the lender has to go along with this. That’s just not true. The joint agreement that you made with your lender doesn’t dissolve with your marriage, and a lender can pursue one spouse if the other does not pay regardless of the language in the divorce decree. If the occupying spouse misses a mortgage payment, both spouses get black marks on their credit reports.

In addition, the departing ex has what’s called “contingent liability” because of the ongoing mortgage obligation. Until the remaining spouse makes the mortgage payment for 12 months, most lenders will count that payment in the debt-to-income ratio of the non-occupying spouse – making it difficult to qualify for a new home loan. Dropping one ex from the loan protects both.

Traditional Refinancing

When there is significant equity involved, the remaining spouse may need to buy out the departing spouse. A “cash-out” refinance is an efficient way to remove the departing spouse from the mortgage while providing the funds for a buyout. Cash-out refinancing involves replacing the existing mortgage with a larger one, with the borrower taking the difference in cash.

If the remaining spouse doesn’t need to cash out an ex, a “rate-and-term” refinance may be preferable – the fees are lower, as is the loan amount, and qualification is easier. Rate-and-term refinancing simply means that you replace your old loan with a new one, without increasing its balance. Alternatively, a “limited cash-out” refinance allows you to roll the refinancing costs into the new loan, upping its balance slightly.

Low-equity Refinancing

If your loan is backed by the government – an FHA, VA or non-subsidized USDA (Rural Housing) loan, and you don’t roll the refinancing costs into the new loan, you won’t need an appraisal to refinance. For FHA and USDA loans, this alternative is called a “streamline” refinance. For VA mortgages, it’s called an Interest Rate Reduction Refinance Loan, or IRRRL.

For loans backed by the government-sponsored enterprises Fannie Mae and Freddie Mac, the Home Affordable Refinance Program (HARP) allows borrowers to refinance and drop one spouse from the mortgage without regard to the property’s value. However, this only applies to mortgages closed before June of 2009.

Dropping A Borrower

You may be able to ask the mortgage lender or loan servicer (the company that collects your payments) to release one spouse from the loan.

Fannie Mae’s Servicing Guide authorizes its servicers to release a borrower as long as “the transferee is capable of assuming the mortgage loan obligation and the mortgage loan.” Unfortunately, if you don’t qualify to assume the obligation on your own, or your mortgage insurer won’t approve the release, the servicer “must deny the request for the release of liability.”

Rent It Out

You might prefer to rent out your home until selling becomes practicable. You’ll have to work out (preferably in writing) how property-related expenses will be handled. It may be worth having a property manager collect the rents, pay your mortgage and divide the expenses and income between you.

Get Help from Your Lender

If you’re in danger of foreclosure, your lender may be willing to help. You can request a mortgage modification, changing the terms of the loan to make the payments affordable. You may get the go-ahead for a short sale, with the lender accepting the proceeds as payment-in-full. Finally, there is the “nuclear” option, with the lender taking back the home and accepting a deed-in-lieu of foreclosure.