For many couples, their largest asset is the equity built up over the years in their home. In the past, selling the joint home during a divorce could have provided enough for a down payment on the purchase new residences. Or conversely, one spouse could have refinanced to stay in the parties’ home and then paid a share to his or her former spouse. Unfortunately, the recent housing bubble and subsequent fall in housing prices has changed the picture.
For many currently going through the divorce process, the conversation is now one of splitting negative equity. Who takes the loss if the value of the house is less than the amount owed? Does it make sense to sell the home at all? One drastic solution employed by some couples is to continue living in the same home but create separate spaces. While this may work for some, there are still several other ways to deal with an underwater mortgage.
Credit the Negative Equity
The first option for divorcing couples is to credit the negative equity to the ex-spouse who keeps the house. An appraisal can determine the value of the parties’ home and the amount that the home is underwater.
To provide a real world example, assume a couple purchased a new home when they married in 2006 for $350,000. Currently, the mortgage on the home is $325,000. However, the value of the home dropped to $275,000. A credit for the $50,000 the house is underwater is offset with a larger portion of the assets in another category (i.e. retirement funds).
Unfortunately for the spouse that doesn’t want the house, if the housing market improves the spouse who stayed in the home may recoup some of the losses over the long-term, ultimately coming out on the better side of the settlement. However, there is another strategy that divorcing couples can use to avoid this possible scenario.
For instance, when one of the parties wants to reside in the home long-term, the parties can zero out the negative equity. The assumption being that the housing market will recover and value of the home will increase.
If the parties originally obtained a mortgage together, there can be some risk for the spouse who does not keep the home. When a former spouse fails to make mortgage payments and both names continue to appear on the mortgage, the bank can, and will, come after both parties. This can hurt the credit rating of the ex-spouse who now has no interest in the home. When possible, it is often best for both parties to refinance any mortgages into just one as part of the property division.
When neither party can afford to stay in the home, one of the last options available is a short sale. However, it is important to note that the lender generally must approve of any sale that is less than the amount of the balance due on the mortgage.
When considering divorce, it is important to contact a family law attorney to discuss issues related to the division of property and options for dealing with an underwater mortgage. A lawyer can assist in negotiations and ensure that your rights are protected during the complex divorce process.