Can we refinance to settle our divorce?

Question of the week:  Can we refinance to settle our divorce?

 Answer:  Yes. No. Maybe.

One area of life that has been impacted by the pandemic has been marriage. Whether it is because couples discovered they were incompatible after being secluded together for 24-hours a day, 7-days a week, for more than a year, or couples knew before the pandemic and quarantine that they were not compatible but did not want to go through a divorce proceeding during the pandemic, or because their shared home has increased significantly in value, the number of marriage separations and divorces appears to be increasing after falling in 2019.

While I do not have any empirical evidence of the increase in divorces in 2021, I do have anecdotal evidence from our applications so far this year. For many years I have had up to four or five transactions a year that were part of a divorce settlement. So far this year that number has already been surpassed, with more on the way.  

For most families, their home is their primary asset, containing most of their wealth in the form of equity. As with other assets, when a couple divorces there must be a plan for the equity and how it is divided, if at all.

In a divorce all the couples’ assets and liabilities are accounted for, to the extent that we have seen settlements that divided houseplants, floor coverings and details on which set of flatware will be awarded to which spouse. While the settlement can get very detailed on asset separation the primary focus is on the higher monetary assets; equity in property, balances in checking and savings accounts, funds in retirement and pension accounts.

Depending on a few factors, a refinance may be the financial instrument that can be used to equitably divide assets.

First, the amount of equity in the home has to be determined, this is done by taking a close estimate of value of the property and subtracting the outstanding loan balance(s).

For instance, if the estimated value of the property is $800,000 and there is a primary mortgage of $375,000 and a Home Equity Line of Credit with a balance of $125,000, the equity is:

 $800,000 – $375,000 – $125,000 = $300,000.

The simple answer to how much equity does each party get is half of $300,000 or $150,000 apiece.

But is that equitable?

Consider if the couple has to sell the property to split equity. The property sells for $800,000, but would they net $300,000 to split? No, they would not because it costs from 7-8% to sell a property in Southern California using a licensed real estate agent.

Besides the real estate commissions there are escrow and title fees, transfer taxes, prorated interest on the current mortgage, perhaps work to clear items listed on a termite report, all these fees add up.

Back to our $800,000, subtract 8% in costs of sale and the net sales price is now $736,000. Pay-off the $500,000 in mortgage and HELOC balances and the proceeds of the sale are $236,000. Or $118,000 for each spouse.

We have a situation where one spouse will keep the house, but in order to do so must “cash-out” the other spouse for their share of the equity. Is the share of equity $150,000 or $118,000?

This makes a big difference if we are refinancing the house to pull funds out to pay off the existing mortgages and also transfer funds to the other spouse.

Primarily, if the amount is $150,000, the total loan amount will need to be $650,000, which is 81.25% of the value of the property. This can create an issue of whether we need mortgage insurance or not, and depending on how the funds and loan is structured if a loan is available over 80% loan to value.

For many of these cases the agreed upon amount is closer to the “net” equity split than the “gross” equity split. In this case extracting $118,000 to be paid to the non-occupying spouse in exchange for a spousal quit claim deed that transfers the property from joint tenancy of the married couple to the occupying spouse as sole owner.

The mechanics of the transaction are important as they impact the rate and costs of the loan. While we are pulling equity out of the property, underwriting guidelines do not consider the transaction as a “cashout” refinance but “limited cashout” refinance IF none of the proceeds go to the occupying spouse. This is important because if any proceeds at closing are paid to the occupying spouse the transaction is a “cashout” transaction which has higher rates and costs than a “limited cashout” transaction.

For example, in the above transaction, Linda and David are getting divorced, Linda wishes to remain in the home with their two children. They agree to David receiving $118,000 from the property and he will sign a spousal quitclaim deed removing himself from ownership, in exchange for the receipt of the funds as well as being removed from any liens on the property.

Linda qualifies for a $618,000 mortgage and we proceed. At the end of the transaction, when the loan funds, escrow pays of the primary mortgage, the HELOC and sends a check for $118,000 directly to David. To close the escrow, Linda had to wire $1100 to escrow to cover pro-rated interest on the new loan. This meets the requirements for a limited cashout refinance.

If pre-funding estimates show Linda receiving $1100 at the close of escrow due to the loan balances being paid off being lower than initial estimates, the transaction is a cashout refinance, it could not proceed until either the loan amount is adjusted downward, say to $616,000, or the loan would be repriced as cashout, a higher interest rate and underwriting re-reviewing the loan to ensure she qualifies with the higher payment.

As mentioned above, the occupying spouse, Linda, must qualify for the refinance mortgage, which may include joint debts that have not yet been separated and paid in full; for example, a credit card with a $25,000 balance or auto loan with a $600 per month payment for the car which David is retaining possession to after the divorce.

Where we run into issues are underwriting guidelines if there is spousal support being paid and received as part of the divorce. The guidelines state that if there is spousal or child support being paid by our borrower as listed in the settlement agreement, it is counted against the borrower.

However, if our borrower is receiving the support payments, they cannot be accepted as income unless the amount is agreed upon in a recorded settlement agreement for the divorce or a separation agreement. As well, and this can be the sticking point, the borrower must show that the full amount of the payments have been received in a timely manner each month for the past six months.

For example, Linda is to receive $2000 per month for spousal and child support payments* from David. They have been separated for three months and through their attorneys have a separation agreement showing this amount to be paid. David began payments in July and has an automatic deposit into Linda’s account on the 1st of each month. For qualifying the income, we must wait to receive final approval and clearance to clear the loan until after the December payment has been made and received.

If David missed the August payment and doubled up the payment in September, we must wait for closing until after the February payment has been made and received, presuming all payments were made on time.

*All support payments must be shown in the agreement to continue for at least three years. If there is a child of the married couple that is generating a payment of $700 per month until she is 18-years old, and will turn 18 four months before our transaction is to close, the $700 per month support payment will not count as income.

Back to our question of the week, yes, you can refinance your property to settle your divorce as part of the division of assets.

Do to the more moving parts than the standard mortgage transaction, the sooner a couple getting divorced begins conversations with us as to options and strategies for one of the spouses to retain the property after the divorce is complete the better. In some cases we have worked with a couple and their attorneys for several months providing different scenarios and options as they created their settlement.

If you know of someone who is considering terminating their marriage, or other relationship with shared property, please have them contact me to go their particular scenario and possible options.

Have a question? Ask me!

Rates for Friday September 10, 2021: No major economic news was released this week that could impact mortgage rates. The 30-year conforming rate is pretty locked in remaining flat for the 9th straight week, the high-balance conforming is unchanged for the 4th week in a row.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS FOR PURCHASE TRANSACTIONS:

30 year conforming                                         2.625%  Flat

30 year high-balance conforming                   2.875%  Flat

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down with 740 FICO score for purchase mortgages.

As you are aware, tomorrow, 9/11, is the 20th anniversary of the terrorist attacks that changed our country and world in less than two hours. September 11, 2001 is one of the moments in our lives that seem so long ago, and so recent because the stark memories each of us holds.

The memory that seems to have faded the most for too many people is how close together our nation drew following the attacks. No red or blue, left or right, urban or rural, as we pondered what could be next. Not unpredictably, the further from 9/11 we moved, the more divisive the language, rhetoric and grandstanding became.

We are the most unique nation in world history. No country has, or has had, the vast spectrum of races, ethnicities, religions, and cultures united as on country. This naturally leads to conflicting ideals, values, and beliefs. It is these differences that enable us to explore other solutions, options and possibilities to improve our communities and country.

It is my hope that the respectful discourse and conversations that were prevalent following 9/11 once again return to our local, regional and national dialogues. My hope is the few on the extremes of parties and ideologies quit screaming and trying to whip up support for their positions by debasing those with whom they disagree and instead engage in respectful dialogues, to find common ground.

In the spirit of the almost 3,000 people who died as a result of the 9/11 attacks, work on respectful listening and speaking to understand those with whom you may not agree on certain issues and see if there are not one or two points you can agree upon. Shake hands, hug, smile, come together.

Have a great week,

Dennis

Past Weekly Rate & Market Updates can be found on my blog page at my website www.DennisCSmith.com/my-blog