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Structuring a Divorce Decree for a Refinance Equity Buyout

July 20, 2023

Divorce Decree Refinance

A divorce is a complicated process to resolve. Division of assets is commonly one of the complex issues. We’re going to cover how to structure the divorce decree to payout the departing spouse using mortgage financing.

What is a home equity buyout?

A home equity buyout is like it sounds—You are buying out a person’s equity or ownership of a home. It is most common in uncontested divorces and inherited property. In this case, we will discuss the former. There are ways to structure a divorce decree to make an equity buyout refinance simpler and cheaper.

What are the types of mortgage transactions which handle a buyout?

To properly explain this, we must provide the rules of mortgage lending. There are two different types of refinances: Rate and Term Mortgages and Cash-Out Mortgages.

Rate and Term Mortgage is a refinance which gives the borrower limited cash and only pays off existing liens like a mortgage. These loans are usually limited to 95% of the home’s appraised value. This is called Loan to Value (LTV).

Cash-Out Mortgage is a refinance transaction that gives the borrower cash in hand. After paying off any existing liens, the borrower gets a material amount of cash. These loans are limited to 80% LTV and usually have a higher interest rate due to the cashout.

Why structuring the divorce decree matters.

To get the lowest rate for an equity buyout and the most flexible terms, the divorce decree needs to clearly state how much is owed for the equity.

For example, the divorce decree states that Husband is to give Wife $50,000 in settlement of marital assets. This is considered a cash-out mortgage if used to pay the Husband because it doesn’t clearly state how much is owed for the equity. The mortgage would be limited to 80% LTV with a rate higher than a Rate and Term refinance.

If the same divorce decree itemizes how much is attributable to which asset, then that is different. The Husband is to give Wife $30,000 from equity from the marital home and $20,000 from savings. The $30,000 is now treated like a payoff on the refinance of the marital home.

This refinance would not be limited to 80%; it would be limited to 95%, and the rate would be lower than a cash-out refinance.

Agreeing on a price

This can get complicated. You can’t look your home up on Zillow and use that amount. While processing the mortgage application, an appraisal will be completed, which can be used as the home’s value. If selling, you will pay real estate commissions and any repairs required. Real estate commissions usually run in the range of 6-7% of the sale price. The repairs or updates will vary based on the condition of the home.

Example #1:
John and Michelle were married five years ago. They bought a home for $200,000 and had two kids but decided to go their separate ways. Their home is now worth $300,000, and they owe $150,000 on their existing loan.

After estimating the costs to prepare and sell the home, they agreed that $270,000 is what the liquidation amount would be. So the final amount of $270,000 less the amount owed of $150,000, leaves $120,000. John will accept $60,000 for his half of the equity.

The divorce decree will state that Michelle owes $60,000 to John for his share of the equity in the marital home for Michelle to own the home.

Michelle will refinance the marital home in her name for $210,000. The loan amount is made up of the original loan payoff of $150,000 plus a payoff to John for $60,000.

A well-phrased divorce decree helped make this happen by clearly stating how much is owed for the home’s equity. This mortgage application can be considered a rate and term and will have a lower rate than a cash-out refinance application. The above example excludes closing costs and prepaids for simplicity.

Example #2
Eric and Ann were married ten years ago. They bought a home for $300,000, had three kids but decided to divorce. The house is now worth $500,000. They owe $200,000 with $150,000 of other assets to divide. The divorce decree states that Eric is to give Ann $250,000 for his share of the net assets.

Since the decree didn’t itemize what part is attributable to the equity of the marital home, this makes a mortgage application harder. Any amount of cash pulled out from a home loan is limited to 80% LTV, and the rate will reflect a rate higher than a rate and term refinance.

In conclusion

If you are planning on divorcing and need to compensate a departing spouse for their equity by refinancing your mortgage, be mindful of wording the divorce decree for the mortgage application. This will allow you to borrow more if needed and at lower mortgage rates. As always, you can reach out to our experienced Homestead loan advisors to help navigate the specifics of this situation. Our team is available 24/7 for your convenience.

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