When a divorcing couple considers what to do with their home, there are three primary options, each with subsequent consequences and choices.
- Sell the house and divide the profits
- One spouse buys out the other
- Both spouses remain as co-owners of the home
Selling the house and dividing the profits is the option with the simplest consequences. Both spouses must agree to sell the home, determine the selling price, and select a REALTOR® to manage the sale of the house. Once the sale has been completed, the profits may be distributed per the divorce agreement.
When one spouse wishes to keep the house and buy out the other spouse, there are several considerations, consequences and choices. With this option some sort of refinancing of any mortgage loan associated with the house is usually required. There are three choices here, each with their own consequences:
- Cash out refinance
The current mortgage is refinanced for an amount greater than the current loan balance; the difference between the new and old loan amounts is considered “cash out”, which can be used in the division of assets between the divorcing spouses.
- Equity buy out
An equity buy out via refinance may offer better refinancing fees and/or interest rates than a regular cash out refinance. The divorce settlement agreement must specify that the marital home is to be refinanced in order to transfer cash value equity from the home to the spouse who will no longer own the home AND there can be no cash out to the spouse who will continue to own the home.
- Refinance plus equity swap for other assets
In a divorce where there are many other assets, a refinance with equity swap may be a viable option. In these cases, the divorce agreement provides the home and its equity to one spouse while the other spouse is provided with other assets of the same value. This may be fairly straight forward, but does require that the spouse keeping the home refinances the mortgage into their name only.
Any time one spouse keeps the marital home, it is important to understand that spouses future income, support payments, tax consequences, and more to ensure that the spouse is able to pay the new mortgage and maintain the home.
If both spouses wish to remain as co-owners of the home after divorce, there are two choices, each with their own consequences:
- Marital lien
- Partnership agreement
With both of these options, it is critical to understand that the two spouses are entering into a business relationship; as such, the agreement, arrangements, and expectations must be very clear.
A marital lien protects the interests in the property awarded to the non-occupying spouse, if that interest is is to be obtained from a future sale or refinancing of the property. A marital lien shares many characteristics with a traditional lien, particularly in that it must have a due date, interest rate, and other terms. A marital lien is generally subordinate to a primary lien or mortgage on the property.
With a partnership agreement, the divorcing spouses enter a business relationship for ownership of the house. This agreement should have terms that define what happens when the property is sold or refinanced, the portion of the equity at the time of the divorce belongs to each spouse, and division of equity at the time of sale or refinance. The agreement should also set a time at which the partnership or co-ownership will terminate and address title vesting.
One type of partnership agreement is a property settlement note. A property settlement note sets up a payment stream from the occupying spouse to the non-occupying spouse, with the payment stream transferring the non-occupying spouse’s equity over time. A property settlement note requires specific terms such as a reasonable rate of interest, a definite term and a principal amount. While the principal payments are not taxable income to the recipient, any interest accompanying these payments is taxable.
Clearly the buy out and continued co-ownership options are quite complicated and have implications on your current mortgage, support payments, decisions on division of other property, title vesting, taxes, and future home purchases. Each divorce is unique and a mortgage lender can work with you and your attorney to help you understand the consequences and choices related to the buy out and continued co-ownership options.