The Family Home in Divorce
The marital home is usually one of the largest, and sometimes the single largest asset, in a marital estate. When considering its disposition, try to focus with your head not your heart. It can be a contentious and complicated process. There are several options to consider,calculations to determine each spouse’s share of the proceeds, retitling of the deed, refinancing of the mortgage, and appraisal of the property, in addition to the costs and decisions regarding preparing the home for sale.
While you are deciding the disposition, remember that both you and your spouse are both liable for the full mortgage payment each month. Any delinquency in payment or default from either spouse can tarnish both spouses’ credit history and impact their ability to qualify for future loans.
Selling the Home
One option to consider is to sell the home at the time of the divorce. While this may be a last resort for some, it may be the only option for others especially when there is so much equity tied up in the home. A house is not an investment. It is a jointly-held asset, provides a place to live and requires money to maintain. In addition, you most likely pay mortgage, interest, insurance and property taxes for the use of the home.
Selling the home can have a large financial impact with capital gains, and expenses necessaryto ready the home for optimum marketability. These consequences need to be factored into the decision and carefully considered to facilitate a smooth sale. Proceeds from the sale can help either or both spouses successfully land on their feet following the divorce. If, however, the home’s mortgage exceeds the home’s value, a short-sale ensues leaving the lender with a loss because they cannot recoup the entire amount of the loan balance. To avoid an outstanding balance that you would be required to pay even after the sale, you will need to secure agreement from all lien holders to accept less than the total amount owed.
In particularly difficult scenarios and economies, you and your spouse may need to resort to other means such as loan modification, foreclosure, deed-in-lieu of foreclosure or bankruptcy in order to divide the family home. While I will not go into these alternative options to divest of this asset in divorce, it is important to know about them for appropriate circumstances.
Buy Out the Spouse
Another option is that one spouse keeps the house, of course, only if this makes financial
sense. This decision requires a solid understanding of post-divorce finances. The spouse who is keeping it will effectively be buying out the other spouse by purchasing the second half of the house. Approach this process as though you were selling it to a third party. Get an appraisal and home inspection, conduct a title search for any liens and re-do the title search immediately preceding final settlement to ascertain that there are no new liens (such as your spouse’s attorney bills) on the property.
While the new spouse easily is removed from the title with the filing of a quit claim deed, this will not indemnify the spouse from any outstanding mortgage. Do not mistake the title to the house and the mortgage as the same instrument. The spouse keeping the house will have to refinance the mortgage. This may be problematic since that spouse will have to requalify for a new mortgage. While the lender may qualify the spouse, granting of a loan is not an indication that the financial cost of home ownership is affordable by the spouse keeping the house.
A silver lining is that the spouse who refinances may potentially qualify to assume a larger mortgage on the home and use the loan to buy out the other spouse. This is especially useful if there are not enough assets available for an outright buyout or if the assets are needed to generate income for the spouse intending to retain the home. If a larger mortgage is assumed, it means incurring greater debt than previously accustomed to in order to retain the home. Burdening yourself with additional debt after a costly divorce and division of assets is usually inadvisable.
Alternatively, if an actual exchange of cash for the home via an excessive loan is not used, the buyout may be financed through offset from investment assets. Often the negotiations to keep a home involve relinquishing these liquid assets. This could mean after tax investments or a share of a retirement portfolio, resulting in the newly single spouse being house-rich but cash-poor. It is important to consider your long-term needs not just the short-term considerations. The spouse buying out the other will be forfeiting opportunity cost–potential compound earnings. and appreciation on the cashed-out investment assets. This opportunity cost needs to be. carefully modeled to discern the true price of the buyout.
Remember that the settlement agreement which may assign all debts associated with the home to your ex-spouse may not be recognized and honored by all lenders. It is imperative to insistthat the spouse retaining the house refinance the house to remove the other spouse from thedebt. Coincidentally, the marital home may still appear on your credit report if the home is not refinanced, no matter that your name is no longer on the deed. Refinancing assures the spouse that is not retaining the home that the debt is removed from credit reports. This is helpful to that spouse’s ability to qualify and assume future debt.
In addition, there are considerations such as loss of the extra $250,000 spousal tax exclusion that increases the amount of capital gains tax incurred for the spouse keeping the home. While this should be offset with reduction in the buyout price of the house, it may not be agreed to in the negiotations. Also, further complications may include any rollover, deferred capital gains from sales in homes prior to May, 1997 under old tax rules regarding residential gains. Similarly, if home-use tax deductions were taken for a home business, there may be recaptured taxes on the deductions that will now be the responsibility of the spouse keeping the house when it eventually sold.
When the spouse who keeps the home eventually sells, they will incur the costs to market the house including updating or renovating any rooms for marketability, staging costs, landscaping refreshing and necessary repairs. This could become a significant amount that has a detrimental effect on liquidity and savings since the costs may be somewhat unpredictable. The risk should not be taken lightly.
Jointly Own/Defer Sale
Finally, a third option is to retain the home jointly. There are several circumstances where this may be a practical choice such as deferral of sale until the children are off to college, deferral of capital gains and taxes that would need to be recognized upon sale, waiting out a weak housing market, or inability of the spouse who wants to keep the house to qualify for an individual mortgage. Several options are available for how to manage this jointly-owned asset by ex- spouses. You may decide to rent the house to a third party or become landlord/tenant and the spouse who is staying in the home becomes the tenant. Arrangements such as these need to be fleshed out with specificity to ensure clear demarcation of who is responsible for what expenses or how you will share responsibilities and decision-making associated with third party tenants.
This option may alternatively involve deferring the division of marital home equity when the value has appreciated or after the family needs have transpired (e.g. kids off to college). However, in this case both spouses will typically be ordered to share in expenses including mortgage, interest, taxes, insurance and maintenance. There are risks to consider with a deferral including market risk if the sale occurs in an unfavorable housing market later on, structural risks with the property as it ages, and hazard risks for events that may not be completely covered by insurance, such as natural disasters.
In this joint situation there are additional downsides. One is that the spouse who wants to buy another home has equity tied up in the marital home. Another is that you will still be entangled and now business partners with your ex-spouse. Many considerations will need to be included in the written settlement agreement for this scenario:
1) terms of the agreement should specify the length of the deferral and stay within IRS
regulations about the number of years the assets are considered divided pursuant to a divorce decree. This is not an indefinite number of years according to the IRS.
2) what happens if either parent defaults or fails to make a timely payment (as this will affect your credit score)
3) who ultimately will make a decision about capital repairs if the you are both in disagreement
4) can one parent borrow against the house as asset for a new loan especially to purchase another residence
5) right of first refusal –when it comes time to sell is one of the ex-spouses able to buy the
property and how does this affect the willingness of a realtor to list the house for sale
6) what happens if the house is destroyed and it is not economically feasible to rebuild or repair
7) what system will be put in place to resolve any other conflicts that arise from the deferral and what is the cost of that process.
A newer trend is called “birdnesting” in which you jointly own the house and rent an apartment nearby. Each spouse alternates living in the house with the children and in the apartment on their own. Whether or not this is a viable solution for your situation is up to you to discern. Depending on how amicable the ex-spouses are, additional financial burden may be involved with the need to rent two apartments.
Implications
In all of the above scenarios, the assumption was that the home was marital property and that each spouse would be entitled to receive 50 percent of the equity in the home. However, this is not always the case, if one spouse owned the home before marriage or provided the down payment from separate property funds on that home or a previous one whose equity was rolled over. It could it be complicated and costly to preserve separate property interest in a home and it does not matter which of the above options is selected as the spouses’ interests in the home needs to be determined.
When both parties want the home and an impasse is reached in negotiations, the courts will ultimately decide who will get the home. Taking into consideration factors such as spousal support, children, income, who has primary custody, and the age health and earning power of each spouse, the judge will make a decision. This means that the decision will be left to the courts, a third party, if the divorce process involves the litigation model.
From a financial perspective, keeping the house may not always be prudent because of the illiquidity, taxes, costs, and unknown future risks. The choices you make regarding the marital home could determine your future financial health and security. While emotions, memories and fondness for homes are commonplace, to stay in the marital home at any cost has negative financial implications if not carefully assessed from a financial point of view. Once you take the emotions out of the process, you will be in a better position to ascertain the financial feasibility and efficacy of any option.
Divorce is one of the most difficult and stressful experiences you’ll ever have. During this
emotional time, it can be hard to think clearly. Be sure to enlist the help of professionals who can guide you and project the future ramifications of any decisions you make. A Certified Divorce Financial analyst is especially trained to add value to this decision-making process and to give clarity to the ramifications of above scenarios for your particular situation.
