The Loan Assumption in a Divorce

The Loan Assumption in a Divorce


Divorcing homeowners need to make informed decisions regarding the equity in the marital residence and mortgage financing opportunities during and after their divorce.   Mortgage financing options available to the homeowners must be adequately incorporated in the details and clarity of a marital settlement agreement.  It is important to identify divorce mortgage options and incorporate these options into the settlement agreement.

Deciding where to live is an essential aspect of divorce. Some people want to stay in their family home, either because they are comfortable there or because they believe the transition will be easier for their children.  However, staying in the family home often requires some changes to the property’s ownership.  There are several ways for one of the spouses to retain the marital home (the retaining spouse) and free the ex-spouse (the vacating spouse) from the existing mortgage.

If the divorce is amicable, the retaining spouse may not need to worry about problems with the vacating  spouse’s name remaining on the title to the marital home after divorce but that can cause many problems in the future.  So, it is usually a good idea to remove the vacating spouse’s name as soon as possible. Even if the divorcing couple is on good terms now, things could eventually sour. Further, getting the vacating spouse to sign documents when both spouses have both moved on with their lives might be challenging.  Once a divorcing couple reaches a settlement agreement regarding the marital family home, they will need to determine how to buy out the vacating spouse or remove him or her from the loan.

Consider the following:  The overall mortgage interest rate in the beginning of  2022 was 3.35% and mortgage rates are now over 6.75%.  If a divorcing spouse who retains the marital residence has to refinance at current rates, the principal and interest payment would go up significantly.

For example, a $300,000 thirty (30) year mortgage at 3.35% has a monthly payment of $1,306.00.

The same $300,000 thirty (30) year mortgage at 6.75% has a monthly payment of is $1,945.00.

What are the existing options if refinancing the existing mortgage is too costly or not possible?  Is there an alternative to a loan refinance?   The recent rise in mortgage interest rates is leaving many divorcing homeowners asking if they are able to retain the marital residence and assume their existing mortgage so they don’t have to refinance and lose their lower interest rate.

One of the most popular ways is loan assumption. A loan assumption is when one spouse  (the retaining spouse) takes over full responsibility of the mortgage loan. This removes the other spouse’s (the vacating spouse) name from the loan, leaving the retaining spouse as the sole retaining borrower.   A loan assumption can be a valuable option for those looking for the possibility of a lower interest rate and a simpler divorce settlement process.

The Mortgage Assumption could be a cost-saving advantage if current interest rates are higher than the interest rate on the assumable loan. In a period of rising interest rates, the cost of borrowing also increases. When this happens, borrowers will face high interest rates on any loans approved. Therefore, an assumable mortgage is likely to have a lower interest rate, an attractive feature to buyers. If the assumable mortgage has a locked-in interest rate, it will not be impacted by rising interest rates.

If an equalization is owed from the retaining spouse to the other vacating spouse and he or she intends to obtain the funds for the equalization through a refinance of the home, a loan assumption may not be possible with this requirement.

When considering a loan assumption, it’s essential for the divorcing couple to work directly with the existing mortgage lender to fully discuss the options. Before speaking with a lender, it helps to have an understanding of what loan assumption is, which loans may or may not qualify, and some alternatives to loan assumption.

Some lenders have more experience working with someone who is going through a divorce and can provide some additional guidance with the needs of a client during and after divorce.

The Loan Assumption in a Divorce

The Due on Sale Clause:  Typically, when a property is purchased, the buyer will obtain a new mortgage to pay the seller for the house, and the seller will use those proceeds to pay off the retaining balance of their mortgage. This common practice exists in part because of due-on-sale clauses.  In order to ensure that sellers don’t transfer their mortgage to prospective buyers, lenders include a due-on-sale clause, also known as an alienation clause. This clause protects the lender’s security against the possibility that a buyer will assume a mortgage that has a low interest rate or terms that the buyer would otherwise be unqualified to obtain.

When Do Mortgage Lenders Use A Due-On-Sale Clause?  The due-on-sale clause allows the lender to require immediate repayment of the mortgage balance when the mortgaged property is sold or transferred. Since a mortgage is a type of encumbrance or lien, lenders are automatically notified when a property that secures a loan is transferred.  Therefore, if a lender discovers that the borrower has attempted to transfer real property to a buyer without their consent, the lender can foreclose on the property.

How Do Lenders Determine When To Invoke A Due-On-Sale Clause?  While the due-on-sale clause is prevalent in contemporary mortgages, it’s up to the lender to determine whether the situation calls for the clause to be invoked. The lender is likely to do so if they:

  • Feel their security is at risk in the hands of an unvetted buyer
  • Believe they can make more money if the buyer applies for a new loan

However, the lender may be less likely to force the borrower to immediately pay off the mortgage in full if the market is weak and the lender is concerned that they will not ultimately be able to recoup their costs by foreclosing on the property.

The Exceptions To The Due-On-Sale Clause Law:  Despite the prevalence of due-on-sale clauses, there are certain legal exceptions that negate lenders’ right to demand the full payment of the mortgage. (The Garn St. Germain Act at 12 USC Section 1701J-3, signed by President Ronald Reagan in October 1982, the Act aimed to ease pressures on depository institutions as the Fed raised interest rates to curb the high inflation of the 1970s) provides the exceptions which should not trigger the Due on Sale Clause with respect to a real property loan). These exemptions include:

Divorce or legal separation: If the borrower files for divorce or legal separation, the property may be transferred to the spouse or child of the marriage without invoking the due-on-sale clause. However, the new owner must occupy the property for this to be the case.

Inheritance: If the borrower dies and a relative inherits then occupies the home, the relative cannot be forced to pay off the retaining mortgage balance on demand. However, if the heir chooses not to occupy the home, the transferred title can trigger the due-on-sale clause. This exception is applicable to any circumstances in which the borrower transfers the property to a child or spouse.

Living trusts: If the property is transferred into a living trust, as long as the borrower continues to occupy the property and remains the beneficiary of the trust, the lender cannot force the borrower to pay off the mortgage on demand.

Joint tenancy: if the borrower entered a joint tenancy agreement when purchasing the house, a lender can’t enforce the due-on-sale clause in the event that the borrower dies. Instead, the surviving joint tenant automatically assumes the entire mortgage and can pay it off as initially planned.

Loan Assumption in a Divorce:

Many couples look into assumptions as a solution for removing an ex-spouse from an existing mortgage. This is done either after a judge awards them the family home or in their divorce settlement.

Removing the vacating spouse’s name from the loan protects the future equity in the property, and it gives the retaining spouse the ability to make decisions regarding the home without them because they are no longer the responsible party on the loan.  Assuming a loan can save closing costs, and it can also preserve the interest rate on the loan.

When properly executed, it offers a solution to remove the vacating spouse from liability in the property, allowing them to purchase another home if they wish. After the vacating spouse is removed from the loan, the retaining spouse are responsible for making all future payments.  The retaining spouse will have the right to sell, refinance, or borrow money against the home without having to involve the vacating spouse after the assumption is complete, as well.  In this process, it is essential to ensure that the quitclaim deed and other mortgage documents are in the proper person’s name.

Loan Assumption and the Settlement Agreement in Divorce:

Assuming a mortgage divorce is a process. The lender will need to make sure that the person responsible for the loan still meets the minimum requirements they’ve set.   Additional information from the person taking over the loan will need to be verified, much like a standard home loan application. The lender will review income statements, asset lists and borrower’s creditworthiness to ensure that they can still make the minimum monthly payments on the loan.

To be the sole retaining borrower, the retaining spouse has to qualify.  One of the qualifications is the ability to carry the loan on his or her own, without assistance from the vacating spouse’s credit or income. But, if the retaining spouse is anticipating an award of spousal maintenance, this can be considered income to the lender.

The lender may like specific language in the settlement agreement or divorce decree regarding the award of spousal maintenance in order to use it to qualify.

If the debt-to-income ratio is high or the credit score is low, the retaining spouse may not qualify to assume the existing loan.

This is why it is essential to contact the mortgage lender, so they know what qualifications need to meet. If this is an option the divorcing couple is exploring, it is important to get in touch with the existing lender early in the divorce. They do not want to find out late in the divorce process that the retaining spouse won’t qualify to keep the home on his or her own.

Below is a list of some of the information the lender will likely require:

  • A copy of the divorce decree
  • Paycheck stubs
  • Bank statements
  • Photo ID
  • Proof of assets
  • A copy of the retaining spouse’s credit report

The lender may require additional documentation during the approval process.

Assumptions tend to be more time consuming than other methods of taking over a loan. The approval process is often lengthy, and the lender might require a new loan title policy.

A new loan title policy would require a title company to research the property and obtain approval from the underwriters, extending the timeline further.

There is also a lot of paperwork involved, and it can take time to get everything signed and filed. If the lender is not familiar with the process, it can take longer for them to complete the paperwork and obtain underwriter approval.  While most lenders are compassionate towards divorce, not all lenders are equipped to deal with loan assumptions properly.

The Benefits and Shortfalls of a Mortgage Assumption:

Two Issues That Cannot Be Resolved In a Loan Assumption:

1. Absolutely no additional equity can be taken out in a loan assumption, so if the settlement includes an equity buyout, a loan assumption is not the right vehicle.

2. A mortgage is not eligible for a loan assumption if a property has additional subordinate financing (a second mortgage) or mortgage insurance.

While there are some compelling reasons to consider an assumption, it is not always the best way to protect the home or move forward after the divorce.  Furthermore, it may not provide the retaining spouse with the funds necessary to comply with any potential buyout, alimony, or community interest payments you need to make to your spouse.

If interest rates are lower, the retaining spouse may want to refinance the marital home at a lower mortgage rate rather than assuming the current loan.

If the retaining spouse needs to pay the vacating spouse an amount awarded to them during the divorce proceedings, the retaining spouse may be able to use the equity in the home to do that.  Home equity loans, also known as cash-out refinances, allow the retaining spouse to take out a portion of the equity you have in the marital home to pay off debts, including divorce settlements in some cases.  These loans can come with a higher interest rate, though. And they may be more difficult to obtain, depending on the retaining spouse income, debt, and credit history.

Loan underwriters also look at the loan amount they are applying for as well as how much equity they have in the marital home. With this option, the retaining spouse could consolidate the existing credit cards and other debts into one monthly payment with a cash-out home loan.

While purchasing a new home might not offer the security you have in your existing home, it is a good way to start your new life. By buying a separate property with a new mortgage, you do not have to worry about removing your spouse from the loan or title documents.

If the divorcing spouse is court-ordered to pay their former spouse a divorce settlement or make alimony payments, a new mortgage with a lower payment might be a better option for you.

If one of the spouses decide to purchase a new home, he or she can use the portion of the proceeds from the sale to pay off any money owed to the other spouse for their interest in property you shared. They can then start over with a new mortgage in a home that fits their life as a single person.

So, if the divorcing spouse have a lot of financial obligations he or she needs to pay off, this could be the right option.

Refinancing is a great alternative to assuming the current mortgage. The retaining spouse just needs to make sure to get their vacating spouse to sign the proper documents at closing to remove the vacating spouse’s name from the title.

The final decision over whether an assumable mortgage can be transferred is not left to the homeowners. The lender of the original mortgage must approve the mortgage assumption before the deal can be signed off on by either party. The homebuyer must apply for the assumable loan and meet the lender’s requirements, such as having sufficient assets and being creditworthy.

Some of the most popular types of mortgages are assumable: Federal Housing Authority (FHA), Veterans Affairs (VA), and the U.S. Department of Agriculture (USDA). Spouses who wish to assume a mortgage must meet specific requirements and receive approval from the agency sponsoring the mortgage.

Conclusion

Not all home loans are assumable. Unfortunately, most conventional mortgages are not assumable, but more and more lenders are offering loan assumptions to their divorcing borrowers. However, loans that are insured by the Federal Housing Administration (FHA) or backed by the Department of Veterans Affairs (VA) or United States Department of Agriculture (USDA) are assumable as long as specific requirements are satisfied.

For most FHA and VA loans, a seller must obtain lender approval for an assumable mortgage secured by a lien on residential real property containing less than five dwelling units, including a lien on the stock allocated to a dwelling unit in a cooperative housing corporation, or on a residential manufactured home.

As always at South Florida Mediation Services, Deborah Beylus is available to help you through this difficult process. Give me a call at (561) 789-0710 or an email at info@southfloridamediationservices.com.