Divorce is complicated. Divorcing your mortgage shouldn’t be.
For most couples, the marital home is their single biggest asset. Naturally, it only makes sense that settlement discussions would center on what to do with the house — who stays, who goes and whether it should be sold. One of the biggest mistakes you can make is treating the mortgage as an afterthought when it should be anything but. Here are five reasons to consider refinancing after divorce.
1. Protect your credit. If your spouse is buying you out of the family home, it’s important to keep in mind that you’re not off the hook. In the eyes of the lender, you remain liable for the joint mortgage unless you sell the house, pay off the mortgage, or your spouse refinances to remove your name. Many people mistakenly believe that coming off the title to the house is the same as coming off the mortgage. Still others believe that the spouse keeping the house can simply assume the mortgage. Unfortunately, that’s rarely the case (though it doesn’t hurt to check with the lender). To put it simply, if you’re still on the mortgage, then you’re at risk. If your former spouse misses payments, your credit will take a major hit, and it can take years to fully recover. If it all possible, the agreement should require that the spouse keeping the house refinances shortly after the divorce (and include provisions to address what happens in the event the spouse doesn’t follow through).
2. Buy out your spouse. If you decide to keep the marital home, your spouse will certainly want his or her fair share of the equity. In order to buy out your spouse, you have a few options. One option is to offset the equity with other assets. For instance, your spouse could keep a greater portion of the bank accounts or retirement funds to equalize the division of property.
If your spouse is the high earner, another option is to forego the spousal support you’re entitled to (commonly referred to as a spousal support buyout) in exchange for keeping the house. If you’re considering going this route, it’s important to work with a Certified Divorce Financial Analyst to run the numbers and assess whether it’s a prudent financial decision.
A cash-out refinance is yet another often-overlooked strategy for coming up with buyout funds. The purpose of a cash-out refinance is to tap into the equity from your home by taking a new mortgage that is bigger than the existing mortgage. The first step is to reach out to a mortgage professional to assess how much you qualify for and confirm this is a viable option. I recommend working with an experienced divorce mortgage advisor who understands the ins and outs of divorce lending guidelines and how they apply to your situation.
3. Tap into your home equity for other reasons. Coming up with funds to buy out your spouse is not the only reason to consider a cash-out refinance. With soaring home prices in recent years, many divorcing couples find themselves house rich and cash poor. And with interest rates at historic lows, a cash-out refinance can provide access to low-cost capital. Don’t make the mistake of overlooking the equity in your house as a source of liquidity. Some of the most common reasons to tap into your home equity include debt consolidation (paying off high-interest credit cards, HELOCs and other loans), establishing a cash reserve (emergency fund), home improvements or putting the money to work in other investments (hopefully generating a higher return than the mortgage interest).
4. Lock in fixed payments. While most homeowners have fixed-rate mortgages, adjustable-rate mortgages (ARMs) have regained popularity in recent years. In fact, roughly 9% of all homebuyers today apply for ARMs. With an ARM, the rate and payments are fixed for a certain period of time, but once this fixed period expires, payments can adjust up or down based on prevailing interest rates at the time. The low initial cost of ARMs can be attractive, but this comes with a degree of uncertainty. It’s important to understand how rising rates would impact your future payments. Then, think through your projected post-divorce cash flow and determine whether you are in a financial position to make those payments. Alternatively, you could consider refinancing to a fixed-rate mortgage (or even an ARM that extends the fixed period further into the future) to protect against the risk of rising rates.
5. Lower your mortgage payment. Interest rates have come down dramatically since the recession of 2008. While mortgage rates have increased recently, they are still at near historic lows. If you haven’t refinanced in the last few years, chances are you may be able to lower your payment. This can be particularly important as cash flow is often tight after divorce due to the higher costs associated with supporting two households. Check with your mortgage professional to see if lowering your payment is a possibility.
At the end of the day, divorce presents a unique opportunity to reassess your finances and start fresh. Unfortunately, tight lending requirements can present a major obstacle to untying the knot. Divorcing couples need to keep their emotions at bay (easier said than done, I know) and stay focused on the finances. By looking at this as a problem to be solved, rather than a battle to be won, you can preserve your long-term financial security. Start by getting educated on how the mortgage fits into your financial situation and recognize that there are opportunities to utilize the mortgage as a powerful tool to meet your financial objectives.