Most people don't plan for it, but about half of all marriages end in divorce. And when a couple decides to go their separate ways, their property has to be divided up or sold. Some property is easier to divide than others. A couple's Beanie Baby collection is relatively easy to deal with in divorce. It has some positive value, can be sold, and easily carved into two pieces. Your underwater home, on the other hand, is the opposite. It can't be cut in two or immediately sold and is harder to deal with because of that.
In the past, most couples going through divorce could sell their home for a profit, split the money, and move on with life. Crazy, right? Now many people have a home with negative equity (underwater) and can't sell it in a regular sale. For them, the house is not an asset that they want to get their share of in the divorce. It's debt they don't want to get stuck with.
So what are the ways to resolve a home with negative equity in a divorce?
- Do nothing. If one of you wants to keep the home, and can afford it alone, you are welcome to do that without telling the bank about the divorce. Of course, if the one that keeps the house defaults on the mortgage payments, the other will have their credit affected. This is a risky option and requires a lot of trust between the two parties. The next option would be preferable.
- Refinance. This replaces your old loan with a new one and is the only way to get one party's name off of a mortgage. If the home has equity and can be afforded by one spouse, they could refinance and get a new loan by themselves. Traditional refinancing requires that there's equity in the home, but the federal government's Home Affordable Refinance Program (HARP) allows qualified borrowers to refinance an underwater loan. The loan must be owned by Fannie Mae or Freddie Mac and the borrower should not have missed any payments in the 12 months before refinancing. More details on qualifying can be found at harp.gov. Since refinancing involves closing on a new loan, you will have to pay closing costs that usually amount to thousands of dollars. A benefit of refinancing is that you can take advantage of today's historically-low interest rates and extend the term of the loan to help bring the monthly payments to a level that's affordable for one person.
- Loan modification. To refinance, the loan has to be current and in good standing. But a lot of couples going through divorce have missed a number of payments and are underwater, so they may need to get back on track with a loan modification and wait to refinance. Loan modifications allow distressed homeowners to come to an agreement with their lender to permanently change one or more of the terms of the loan and resume making monthly payments. The interest rate and term of the loan can be changed to reduce the monthly payment to 31% of the borrower's monthly gross income. Principal reduction is possible, as well. Banks can modify a loan under the federal government's Home Affordable Modification Program (HAMP) or through their own in-house programs.
- Short sell the house. If no one can afford to keep the underwater home, a short sale can be pursued. This involves getting permission from the lender to sell the home to a buyer for less than is owed on the loan. Lenders can be open to taking less than they are owed on the loan because it may be cheaper for them than foreclosing. You have to convince the lender that it's in their best interest to allow a short sale, which can take time. A short sale will mean that there's a negative mark on the borrowers' credit report, but it does allow the former spouses to get out of the mortgage. It's important to include a deficiency judgment waiver when getting approval for a short sale. Without it, the bank could sue for the difference between what you owe on the loan and what the home sells for.
Getting A Mortgage After Divorce
A short sale or missed mortgage payments will involve a negative entry on the borrower's credit report. That doesn't mean you can't get a mortgage again, but for a period of time lenders will see you as a bigger risk, and may charge you a higher interest rate because of it. That's all the more reason to do something to resolve your mortgage issues as soon as possible. The longer you put it off, the less options you are likely to have.
Getting divorced is a nightmare for a lot of people, both personally and financially. Even in a best case scenario, it's still a major life change. You don't want to make the stress worse by adding foreclosure on top of that. Soon-to-be ex couples are advised to put their emotions to the side as much as possible and come to an agreement about their home loan that will benefit both of them going forward. Tough decisions have to be made about what to do, whether it involves a short sale, loan modification, or refinance.
Couples know that they need a divorce attorney, but they may also need another lawyer to help them deal with their mortgage, especially if applying for a loan modification. An application for a loan modification is complex and most that are completed without the help of an attorney are denied. When hiring an attorney for divorce, foreclosure defense, or loan modification assistance, make sure to find someone with a proven record of helping people in your situation. That way you know you have the best chance of getting what you want and putting your divorce and/or mortgage problems behind you.
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