Divorce is never easy. And when real estate is involved, it can get downright exhausting.
Sometimes neither of the spouses wants to keep the house -- too many bad memories, perhaps. So the simple answer is to sell and move on.
When kids are involved, though, the breakup becomes much more complicated. Often, one spouse wants to remain in the house so the children aren’t uprooted, so the other has to move out.
But how do they split the value of the family residence? If one spouse just wants to bail, they can sign over their share of the property and walk away. Problem solved -- or at least alleviated. Or, if one spouse has the ability to buy out the other’s interest, a major stumbling block can be avoided.
Those two scenarios are rare, however. More often than not, the parties go to war over the issue.
If they can’t come to some kind of understanding, a judge will do it for them. But it need not get to that point if the parties consider a cash-out refinancing.
For simplicity purposes, say the house is worth $100,000 and the balance on the mortgage is $50,000. By refinancing to the full $100,000, there is $50,000 on the table that the remaining spouse can use to buy out the spouse who is leaving.
Simple enough, except that there often isn’t enough equity in the place to do a normal cash-out refi. For example, Fannie Mae, perhaps the largest source of money for home loans, requires an 80 percent loan-to-value ratio (LTV) to be retained in the property. And the Federal Housing Administration (FHA), the government agency that insures loans against default, expects an 85 percent LTV.
Consequently, in the example above, the parties would only be able to pull $30,000 out of the house if Fannie Mae was purchasing the loan from the primary lender, as is often the case. If the FHA was underwriting the new mortgage, they could pull out $35,000.
In neither case, then, would there be enough money to buy out the departing spouse’s half-share. But both Fannie and the FHA are aware of the housing and mortgage issues divorce can cause. And each one has a special refinance option, neither particularly well-known, to help solve the problem.
Under the FHA “divorce” option, one spouse co-borrower can refinance the property up to 97.5 percent loan-to-value ratio instead of the 85 percent ceiling required of other borrowers.
“This has a huge advantage, especially when a property has declined in value or has not gained enough equity for a normal FHA cash-out refinance,” says George Souto, a loan agent with McCue Mortgage in Middletown, Connecticut, who blogged about the program on the Active Rain real estate website.
There are rules, though. As Souto points out, the remaining co-borrower has to use the proceeds of that loan to pay off his or her former co-borrower. Also, the spouse who retains the property must obtain a divorce decree, settlement agreement or other legally binding and enforceable equity agreement that documents the amount of equity awarded to the other spouse.
Of course, the spouse who remains on the new mortgage must qualify for the loan with just his or her own income and meet all the other FHA guidelines. And in no case can he or she receive any of the proceeds from the new loan.
Under Fannie Mae’s divorce-refi option, the property can be refinanced up to 95 percent of its current value, as long as the property was jointly owned for at least 12 months prior to the day of the application for the new loan. And the parties must document that fact.
Again, the spouse who remains must not receive any of the proceeds, and must be able to qualify for the new loan on his or her own. And both parties must execute a written agreement stating the terms of how the property is to be transferred, the purpose of the transfer and how the funds from the refi will be used.
Freddie Mac, another major investor in mortgages, also has a refi option for divorcing couples. Under its program, the property must have been owned by the warring factions for at least 12 months. Also, the loan file must state that the property was occupied as a principal residence, and there must be a written agreement stating the terms of the transfer and the disposition of the refi proceeds.
The new mortgage amount is limited to the amount of equity used to buy out the other co-owner, plus the amount needed to pay off the old mortgage, any junior liens and closing costs, financing costs and any escrows and prepaid items such as property taxes.