When Refinancing After a Divorce Does (and Doesn’t) Make Sense
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One of the most common reasons for removing a name from a mortgage is divorce, which can be messy. You and your spouse must work through the logistics of dividing valuable assets, including your home.
Regardless of whether you’re refinancing after divorce or using another method to remove a name from your mortgage, you’ll need to decide whether you want to sell the house and split the profits, or if one person will keep the home.
How divorce impacts your ability to refinance
There are several ways divorce can affect your ability to refinance a mortgage, including:
- A higher debt-to-income ratio. If you jointly applied for your existing mortgage with your spouse, the debt-to-income (DTI) ratio on your application took into account both of your incomes. When you refinance individually, your spouse’s income is taken out of that equation. This could significantly raise your DTI ratio and make it harder to qualify for a refinance.
- A higher credit utilization ratio. You may be required to close joint credit accounts, which lowers your total available credit and raises your credit utilization ratio.
- A lower credit score. If any joint accounts remain open and your spouse is unwilling or unable to pay what’s due, late payments can negatively impact your credit score. Additionally, a vindictive spouse could make large purchases on joint accounts to intentionally rack up debt and damage the other spouse’s credit history. You may also miss payments on credit accounts because you’re preoccupied with the divorce.
Additionally, if all financial accounts were in your ex-spouse’s name, you might have a limited credit history — weakening your chances of approval for a range of financial products.
Qualifying for a divorce refinance
A mortgage refinance involves taking out a new home loan. That means you’ll need to meet several eligibility requirements before you’re approved for refinancing after a divorce. Be prepared to:
- Have at least a 620 credit score for a conventional loan refinance. For an FHA refinance, the credit score minimum is 580.
- Have a maximum loan-to-value (LTV) ratio of 97% for conventional loans and 97.75% for FHA loans.
- Have a maximum DTI ratio of 45% for a conventional loan and 43% for an FHA loan. You may qualify for a refinance with a DTI ratio up to 50% in certain circumstances.
If you and your co-borrower have built a significant amount of equity in your home, you may need to get a cash-out refinance to buy out their portion of the equity. In that case, the maximum LTV ratio allowed on a cash-out refi is 80% for both conventional and FHA loans.
3 reasons to refinance after divorce
Your ex-spouse may still be on the mortgage
The biggest issue with refinancing before a divorce is that, in order to take advantage of a lower DTI ratio with your spouse, both spouses’ names will need to be on the new mortgage, even though only one spouse will continue living in the home and making the mortgage payments. The problem? Although one spouse will no longer live in the house after the divorce, they would still be responsible for the mortgage.
Your ex-spouse continues to play a role in your financial decisions
When you make the decision to divorce, you’ll make financial decisions on your own. If you refinance with both names on the mortgage before your divorce, your ex will continue to be connected to your finances.
You could get the liquidity to buy your ex-spouse out
Your divorce decree may require that the spouse keeping the house buy out the other spouse’s half of the available home equity, if applicable. For example, if Mike and Leah own a $300,000 home on which they owe $150,000 on their mortgage, they have $150,000 in equity. Each spouse is entitled to half that amount: $75,000. If Leah plans on keeping the home but doesn’t have $75,000 in cash or other assets to buy out Mike’s share, a cash-out refinance may be the only way to liquidate Mike’s portion of the equity without selling the home.
3 reasons not to refinance after divorce
You’ll have a better chance of qualifying for a new mortgage
As mentioned previously, two incomes mean a lower DTI ratio, and most mortgage lenders want to see a ratio of 43% or less.
Let’s say Mike and Leah earn a gross monthly income of $5,000 each, or $10,000 total. Their mortgage payment is $2,000 per month, and they have other debt payments totaling $1,000 per month. Their pre-divorce DTI ratio is 30%.
The former spouses are planning to split their non-mortgage debt 50-50, which would equal $500 per month, per person. If Leah wanted to keep the house after the divorce, assuming her monthly mortgage payment would remain at $2,000, her DTI ratio would be 50% ($2,000 mortgage + $500 other debt payments / $5,000 gross income = 50%). If Leah waits to refinance after the divorce, she might have trouble getting approved with a 50% DTI ratio, though it’s not impossible with some loan programs.
You can make an informed decision to keep or sell the home
When one spouse wants to keep the house in a divorce, determining your monthly payment amount after the refi may be a good idea. Doing the math can give both parties an accurate look at how expensive the payments would be for whoever keeps the house.
Realizing you aren’t prepared to solely take on the financial burden of a mortgage and deciding instead to sell your home could save a lot of time and money later. Getting a home appraisal to determine your home’s current value may be helpful when you divide assets and choose what happens to the house in a divorce.
You could lock in a lower mortgage interest rate
While rates are hovering near historic lows, even a small jump could mean thousands of dollars more in interest payments over the course of a 30-year mortgage.
Let’s say Mike and Leah from our previous example are weighing whether to refinance their $150,000 mortgage before or after the divorce is finalized, which they anticipate happening sometime in the next 12 months.
Mortgage rates are unpredictable and can rise at any given point, so let’s say rates are currently about 3%, but increased to 3.5% a year from now. The table below offers a comparison of the two loans, using LendingTree’s mortgage payment calculator:
|Mortgage 1||Mortgage 2|
|Monthly payment (principal and interest)||$632.41||$673.57|
|Total interest paid||$77,666.18||$92,484.13|
As you can see, waiting a year to refinance (when rates are higher) could cost nearly $15,000 more in interest over the course of a 30-year loan.
How to remove a name from a mortgage without refinancing
Can you remove someone’s name from a mortgage without refinancing? Well, maybe. Divorcing spouses wondering how to keep a house in a divorce may mistakenly believe that if the divorce decree awards the home (and outstanding mortgage balance) to one spouse, they can simply have the other spouse’s name taken off the mortgage. But a divorce decree doesn’t have the power to nullify your mortgage contract.
However, there may be a way to take a name off a mortgage without refinancing — if you can qualify for a mortgage assumption after divorce.
When you assume a home loan, you take over the interest rate, monthly payments and loan term of an existing mortgage. Conventional mortgages and government-backed home loans from the Federal Housing Administration (FHA), U.S. Department of Veterans Affairs (VA) and the U.S. Department of Agriculture (USDA) typically allow mortgage assumptions after divorce.
If you and your spouse decide that one of you will be assuming the mortgage after divorce, check with your lender about whether the other spouse is still liable for the loan. This is especially important if the spouse keeping the home fails to maintain on-time payments. If the other person still has the mortgage listed on their credit report, they will be negatively affected by any late mortgage payments their former spouse makes.
What happens if the house isn’t in my name?
What if the spouses didn’t jointly borrow the mortgage? What happens if one spouse’s name is not on the house deed in a divorce?
It depends on whether you live in a “community property” state or an “equitable distribution” state. There are nine community property states, according to the IRS:
- New Mexico
If you live in one of these states and you or your spouse individually purchased the home you lived in as a couple after you married, each spouse owns a 50% share of the home at the time of divorce — even though only one spouse’s name is on the house deed and title. The 50-50 split generally applies to all property both spouses acquired over the course of the marriage. Any property you acquired separately before the marriage or after the divorce or separation still belongs only to you.
For all other states that recognize equitable distribution, a divorce judge will fairly divide any property, including a home, that the couple acquired during the marriage. Keep in mind that fairly doesn’t always mean equally — in other words, there might not be a 50-50 split. If one spouse purchased the home while single and the other spouse moved in after getting married, for example, the house solely belongs to the spouse who bought the home.