One of the biggest issues we see in divorce situations is who gets to keep the house. In a majority of cases when the wife has primary physical custody of young children, she wants to stay in the house. This is understandable as she may want the kids to continue in the same school or she simply wants to keep their lives and routines as consistent as they were pre-divorce.
While we certainly can understand the desire to keep the house, this decision can present some financial risks to one or both of the divorcing parties.
Let’s look at a few possible scenarios and their potential consequences:
1. The parties agree that the wife will stay in the house and buy out the husband’s share of the equity. In situations where the husband and wife have similar incomes and savings, this may be a perfectly viable option. The wife will simply get a mortgage in her own name, the husband’s name will be removed from the deed and the wife will pay the husband half of the equity in the home from existing savings or investments.
The situation gets trickier when the wife’s income may be significantly lower or if she has been out of the workforce while caring for the children. It may be difficult or impossible for her to qualify for a mortgage in her own name based on her current income (or lack thereof). Although lenders will include child support and/or alimony received into their calculations, most will want to see 6 – 12 months of consistent payments and a court order before they will consider the support as income. So even if your divorce becomes final next month and the agreement calls for you to receive monthly support, until there has been a trail of 6 – 12 months of payments, the bank will likely not include those payments as income for you. In addition, many spouses may receive financial support during separation but before the divorce is final. Because these payments are not subject to a court order, they will also not be counted.
2. Because the spouse who will stay in the house cannot qualify for a new mortgage, it is agreed that this spouse will pay the mortgage and related expenses even though the loan is in the other spouse’s name. This might seem like a reasonable decision at first. In the interest of keeping the children in their home, the spouse whose name is on the mortgage agrees to let his or her ex live in the house as long as they pay the mortgage, taxes and insurance. At some point in the future- perhaps when the kids are out of school- the house can be sold and the equity can be divided then. There are a few potential pitfalls with this scenario.
First, the spouse who will not be living in the house may want to buy another home someday. While some high earners may be able to qualify for a 2nd mortgage, most people will not be able to get a loan to purchase a new home if they still have a mortgage on the first house.
Second, what happens if the spouse living in the house is late paying the mortgage? Or, even worse, stops paying it altogether? Even though the divorce agreement may explicitly state that the spouse in the house is responsible for paying the mortgage, the lender only recognizes the name on the note. If there are delinquencies or even a foreclosure, it will affect the credit of the spouse whose name is on the mortgage. Because there are no adverse consequences for late payments by the spouse in the house, he or she may decide to pay other expenses first, while knowing that the late payments will only affect the ex.
3. One spouse insists on keeping the marital home, so the other spouse ends up with most of the savings, investments and retirement accounts. This is another common situation we run into. I’ve seen many divorce agreements which divide all the marital property equally, but one spouse ends up with primarily liquid assets (like savings accounts, stocks, mutual funds) and the other ends up with the house, which is very illiquid. If the spouse who gets the house has little or no emergency fund or backup savings, they are truly playing with fire. An adverse situation like a job loss, disability or major home repair can ruin them financially. If you decide to forgo other more liquid assets in favor of keeping the house, make sure you plan for the unforeseen issues that inevitably seem to occur.
The point here is to consider all the “what if’s” that could occur in the future before making a decision about what to do with the marital home. It’s often your biggest marital asset, so think about all the pros and cons before signing your agreement.