What To Do When Refinancing Is Not An Option

When a divorcing couple owns a home together, one of the spouses will be awarded the house and must then assume the mortgage singly. The names on the existing mortgage cannot be changed, and the assuming spouse must therefore refinance to take on the remaining mortgage balance. What happens when the spouse who wants to remain in the marital home will not qualify to refinance the mortgage?

There may be several reasons why refinancing is not feasible:

• The refinancing spouse does not qualify based on his or her income and assets. This could be because the spouse has low or no income, or is newly self-employed (banks typically want to see at least 2 years of self-employment income.) Also if the spouse has significant other debt the loan could be denied.
• The house is underwater and has no equity, or has very little equity. This is not uncommon after the recent housing recession.
• The refinancing spouse has bad credit. This may not prevent refinancing, but could result in a high interest rate and a high monthly mortgage payment that the spouse cannot afford.

In this situation there are a few options to consider:

v The house could be sold and the equity awarded to the spouse who had intended to live in it. This spouse could then hold onto the equity until they are in a better financial situation to take out a mortgage.

v If the house is underwater it could be disposed of via a short sale. However the couple may still be liable for the difference between the mortgage and the sale proceeds unless the bank agrees to forgive the difference (in which case the forgiven amount is taxable as income, as of 2014.) Similarly it could be sold via foreclosure. This is not a great solution, but is one way to dispose of the home.

v The parties could continue to co-own the house until a future date when either one spouse is in a better position to refinance, or until they agree to sell it. In this situation there are many associated factors to consider:

• Who will pay the mortgage, property tax and insurance? While one spouse may take responsibility for mortgage payments, both names are still on the mortgage and both parties are legally responsible for them. That means the party who isn’t making the payments may have to take them over if the responsible party stops making payments.
• Mortgage payments can be considered alimony, if it is stipulated in the divorce decree. The payor spouse is thus covering the mortgage and covering alimony at the same time. Note, however, that only one-half of the payment is deductible as alimony and each party can claim one-half of the interest paid on their tax return.
• Who will take care of maintaining the home? This includes usual expenses (lawn care, chimney cleaning, pest removal, etc) and unexpected or large, capital expenses (roof replacement, repairing the furnace, replacing the hot water heater, etc.)
• When the house is eventually sold or refinanced, how will the equity be split?

All of these issues mean that someone will need to keep a detailed accounting of expenses and payments between the two parties.It is important to explore the possibility of refinancing before the divorce is finalized.

Waiting until the divorce is done, and then finding out that one spouse doesn’t qualify to refinance, means the spouse who has left is still on the hook for a mortgage on a house he/she doesn’t live in. In addition the spouse who moved out may not qualify for a new mortgage because of the debt he/she still owns. That’s a surprise that no one wants!