How to Purchase or Refinance a Home After a Divorce
Couples who decide to end their marriage with a divorce certainly didn’t go into the arrangement knowing full well that at some point a divorce will be a definite life event.
No, instead of living a life of indescribable bliss the road took another turn and the marriage came to an end.
For any number of reasons but primarily it’s because the couple realized getting married wasn’t what they expected. Instead, the couple had a vision of starting a family and buying their first home and raising their children and retiring together. Unfortunately, the average marriage lasts about 7 years.
In southern California where home prices are much higher than the national median and the median income isn’t enough to keep up with home values it’s common for a couple buying a house to combine incomes in order to qualify for the home they want to buy. In California there are two issues to consider when buying real estate- the chain of title and the mortgage.
Title- What Is It?
If you’ve bought a home before when you went to the closing and signed your loan documents you also noticed for charges related to title insurance. Title insurance is in fact an insurance policy that protects the lender as well as the property owners. Title is a legal document recorded in the county and shows the various owners over the years and who now are the legal owners. The title report will show the sales transactions over time from the original land owner until today. All parties listed on the title report will have some degree of legal interest in the property. For married couples, title is held as Husband and Wife with Joint Tenancy or simply Joint Tenancy.
There are several ways to hold title when more than one person owns real estate, Tenants in Common, Community Property and Community Property with Rights of Survivorship. Most all transactions with married couples take title as Joint Tenants s both have an equal interest in the property and in case of the death of one of the persons ownership transfers to the surviving spouse. If you are curious on how you should take title as a married couple your title company can help or you can consult with a real estate attorney but most select Joint Tenancy.
Title insurance protects the owners of the property as well as the lender in the instance of previous fraud, unresolved claim or any issue that might question the legal transfer of the property in the past. These issues are referred to as “clouds” on the title.
For example, you buy a home and move in and really enjoy your place. You’ve added your own touches to the property and totally remodeled the kitchen and master bathroom. Three months later you get a knock on the door. It’s a guy who wanted to let you know that the home was transferred illegally and he still has a legal interest in the property and he either wants the home back or you pay him some money. As it turned out, there was a divorce involved and the “ex” was never properly removed from title nine years ago. What happens now?
A claim is made and the title insurance policy pays the settlement and title is “cured” showing you as the legal owner. In today’s environment, no mortgage company or bank will place a loan unless there is a complete title review and a title insurance policy in place at the closing.
The Mortgage After a Divorce
While title provides evidence of the legal owners and any other interests, the mortgage is a promise to pay the mortgage company based upon the terms of the note. The note will typically have payments due on the first and a late charge assessed after the 15th of the month. The note will also have clear language on what could happen should payments be made more than 30, 60 and 90 days past the due date and explains the lender has a legal interest in the property until the mortgage is retired. The mortgage company will also file a lien on the property, securing the collateral.
When a couple applies for a mortgage the lender reviews the employment, income, assets and credit histories of both who are going to be on the loan. The lender verifies the income using pay check stubs and W2 forms and income tax returns if one or both of the borrowers are self-employed. Bank statements are required showing sufficient funds to cover the down payment as well as closing costs and also a certain amount of funds relegated as “cash reserves.” Cash reserves are described as the number of months’ worth of mortgage payments, including not just principal and interest but also a monthly allotment for property taxes and insurance. If the total monthly payment adds up to $5,500 and the loan guidelines ask for six months’ worth of reserves, the lender will need to see 6 X $5,000 = $30,000 in cash reserves in addition to the funds needed for the down payment and settlement charges.
The lender will use both incomes to qualify for the amount being applied for. If spouse #1 makes $10,000 per month and spouse #2 $3,000 per month the total amount used for qualifying is $13,000. Lenders will require at least a two year employment history and steady income while showing the income is likely to continue into the future. Part time income can also be used as can bonus income or commissions as long as there is at least a two year history demonstrated and the lender determines the extra income will more than likely continue into the future. Short term, part time income won’t be allowed nor can an occasional bonus or commission if there is no history shown.
For couples with only one income as long as the couple can qualify with just one income, the spouse without the income may still be on the mortgage and will be reported to the credit bureaus. Yet there is no requirement that both spouses must be on the loan if only one shows income.
Debt Ratios After A Divorce
When evaluating a mortgage application lenders review the current monthly credit obligations in addition to the new total house payment on the new property. This percentage is called a “debt ratio” and lenders like to see a mortgage payment be somewhere around one-third of gross monthly income and around 40% for all monthly debt. These numbers are not set in stone and are guidelines only but are in fact a common reference point.
What debt is included? The housing payment is principal and interest, monthly property tax allotment and insurance, referred to by lenders as PITI. If the gross monthly income is $13,000 a comfortable house payment of one-third of that amount is around $4,300. Additional monthly debt includes revolving debt such as from credit cards and installment debt such as an automobile loan. Day care is also a listed obligation but other monthly payments such as for food and entertainment are not considered.
A couple may have joint credit obligations while at the same time having individual credit accounts. For example, someone who was single and financed an automobile or an individual credit card. After marriage and a joint credit report is pulled, lenders use all debt, regardless of who is listed as the responsible party. It’s not all that uncommon to see one spouse have multiple credit accounts and higher monthly debt while the other has very little or no outstanding debt. Regardless of who originated the original debt, when a mortgage application is submitted and a credit report pulled, all credit payments are used to calculate debt ratios regardless of who is responsible for payment.
On occasion there may be a situation where one of the borrowers has poor credit. In instances where one party has great credit and one not-so-great, lenders will use the lower of the two middle credit scores. Lenders pull a credit report and request credit scores from all three credit bureaus, TransUnion, Equifax and Experian. Spouse #1 might have scores of 776, 760 and 764. If applying alone the lender would use 764 as the qualifying score. If spouse #2 has scores of 573, 592 and 579 the lender will use 579. The lower of these two scores is 579 and is the score lenders will use to evaluate the loan application and in most instances the 579 is way too low for a traditional loan approval.
In such an instance a sale and a loan can still be placed by removing the spouse with the poor credit from the loan application altogether. Doing so in this example means the qualifying score is 764 and the loan can be approved as long as the qualifying spouse can qualify using that person’s individual income while still being able to afford spouse #2’s monthly credit obligations. In this fashion, spouse #2 is not on the mortgage but is still a legal owner and listed as such on the title report. Some lenders refer to this scenario as a “Non-purchasing Spouse.” On title, but not on the mortgage.
As you can see, title and mortgage are in fact different but they both have a separate impact as it relates to divorce. Understanding this it means both must be on title as legal owners but only one needs to be on the mortgage if that’s how the couple wants it.
After A Divorce = Debt
Okay, now that we’ve explained the impact of both ownership and the mortgage, let’s get to the tricky part- what happens if a couple buys a home with a mortgage and later divorces with an outstanding mortgage balance?
There are some options here with the easiest probably being selling the property and splitting the proceeds. If a couple buys a home together and sell the home after divorcing they will split the proceeds. That is if both parties agree to that scenario. And that’s the catch here, what happens during and after a divorce is negotiated between the two parties with oversight from the judge presiding over the divorce proceedings. The couple could agree that one spouse receive 40% of the proceeds or even that one spouse receives everything after the sale. It’s up to the negotiations and what is written into the final divorce decree.
Beyond selling the home outright and splitting up the money, it’s probably more common where one spouse remains in the home and the other finds a new place to live. This is usually the case when there are children involved and the couple wants to keep the kids in the home where they grew up and then later deciding whether or not to sell the home once the children leave the nest.
Okay, now what happens as it relates to title and the mortgage? To remove one of the owners a “quitclaim” deed is signed and recorded where one party releases, or “quits” any interest in the property. Once the quitclaim is recorded there will be only one current owner and listed so on the title report. That is again if that’s what both parties agreed to.
Next what about the mortgage? Well, that’s a different story. One question that pops up when couples divorce and there is an outstanding mortgage is, “Does the mortgage company want someone to replace the ex-spouse because there is only one income now?” This question really applies to any instance when something significant happens that is different from when the original loan was approved.
When lenders evaluate and approve a loan they do so using the circumstances and information at the time of the application. There is nothing in the note that states if there is a loss of a job, an extended illness or a divorce requiring the person remaining in the property must qualify for the note all over again as an individual. As long as the mortgage is paid on time as per the note the lender doesn’t care. The very same occurs when someone buys a house as a primary residence then later moves out, buys another and keeps the old house as an investment property. The mortgage company cannot change the status of the mortgage as one for a non-owner occupied property and increase the mortgage rate. Can’t happen.
But here’s the important part in this scenario- while one party can sign over ownership with a quit claim deed and be removed as a legal owner of the property the mortgage company doesn’t release that same individual from the responsibility of paying the mortgage.
The only way to remove one of the original parties from the mortgage is having one of the parties refinancing individually without the benefit of the other parties’ income. To remove someone from a mortgage means replacing the original loan by refinancing.
The impact of this means someone can sign a quitclaim deed but still have a mortgage payment that appears on their credit report. Let’s say a mortgage payment is $3,500 and one party stays in the home and one leaves. The $3,500 will appear on both individuals’ credit reports long after the divorce was final. That is unless the loan was refinanced and the person remaining in the home must qualify with his or her own income. If the income is not enough to qualify for a refinance, then an outright sale is possible.
What the Judge Says…
When someone applies for a mortgage to buy a home or refinance an existing mortgage and there is a divorce in the past, lenders will want to see a copy of the final, signed divorce decree. The signatories must be not just the couple but also the judge. The divorce decree is not something that lists out the obligations of the divorcing parties, only the divorce decree can do that.
It’s common for a couple to negotiate who pays for what. Someone might get the car and pay for it or someone might get the car and the other party pays for it. Whatever is agreed to and appears in the signed decree must be followed. Okay, but what if the divorce decree says the individual vacating the property is also responsible for making the mortgage payment? When the responsible party applies for a new mortgage to buy a home there will be the old mortgage debt that will still be counted. That of course means that individual must be able to qualify for two mortgages- the one the “ex” still lives in and the new purchase.
What if the judge awards the house to one person while also requiring the individual keeping the home is responsible for the mortgage and not the person who quitclaimed ownership? Unless the person who keeps the house and the mortgage refinanced, the person who was not awarded the house nor responsible, according to the judge anyway, for the mortgage payment, that individual can still be held liable for that payment and can affect qualification. Sometimes allowances can be made for a new lender to ignore the outstanding mortgage payment as long as there can be proof shown the current owner has made the payments on time for the past two years or so. Still, without a refinance this can be a problem. Lenders aren’t subject to the judge’s orders- the couple is.
Support Payments and Debt After A Divorce
Let’s add one more important piece to this picture- support payments, support to the ex-spouse in the form of alimony and support for school-aged children. Child support payments are counted as a debt just as with any other such as a credit card or car payment. However, if the child support payments show the payments will halt once the children reach a certain age or graduate from high school, a common stipulation, lenders can ignore the child support payment. Alimony paid to a spouse may also end if the ex-spouse gets remarried. Again, it’s all in the signed decree.
Let’s say an individual is charged with a $3,000 per month alimony payment to the ex-spouse. There are no child support payments but there is the $3,000 per month alimony and the old mortgage payment of $4,300. So far, that’s $7,300 in debt for housing and support payments and when a new mortgage payment or rental payment is added that can keep a lot of ex-spouses from qualifying. The $3,000 alimony is considered a monthly debt and the lender will not make any allowances regarding the likelihood of the $3,000 continuing into the future. The lender simply assumes it will be there forever. This keeps many from qualifying for a new mortgage. Two mortgages and alimony can be a huge obstacle.
Debt and Income Reduction
There is a solution and we have it. We have a special mortgage program that looks at support payments differently. Instead of counting the $3,000 monthly support payment as a debt we deduct the $3,000 from the overall monthly gross income of the borrower. But isn’t that the same thing?
No, not at all. In this fashion, the monthly debt has an impact of two to three times more compared to reducing the alimony from income. Let’s say the borrower has a $3,000 alimony payment and monthly income of $12,000. In this way, the income used is $9,000 and using a housing ratio of around one-third the house payment would be around $2,970.
Let’s now assume there is no additional debt. No car payment or credit cards at all. If we count the $3,000 alimony payment as a debt and still using the $2,970 housing payment, total debt adds up to $5,970 per month for a debt ratio of nearly 50%. Now let’s say you add in a car payment of $700 and a credit card payment of $300, total debt is now $6,970 and the total debt ratio is 58%. That’s way too high for a total debt ratio.
If we add the additional $1,000 debt for the car and credit card but subtract the alimony from income, the debt ratios work out to 33% for the housing ratio and 44% for the total debt ratio. In this common-sense approach to alimony payments, the borrower in this instance would easily qualify.
There are so many factors to consider when a divorce enters the picture during a mortgage application but having monthly alimony counted as a debt and not a reduction in income it, shouldn’t be an issue. If this is you or you know someone in this situation, we need to talk.