Just about every divorce case involves a house and its corresponding mortgage. In a small number of cases parties agree that dissolution of the marriage is also an opportune time to downsize the residence, but in most situations, at least one of the parties wants to keep the residence, even if just, “for a while.”
This is where complications can arise. Certainly one spouse can transfer their interest in the home to the other. Nevertheless, any such transfer comes “under and subject” to existing liens and encumbrances. In most instances, when the parties acquired title to their home they did so subject a promissory note payable to the lender secured by a mortgage. A mortgage is essentially a pledge of the home to secure the money due under the promissory note.
The promissory note is a “joint and several obligation.” That means both borrowers agree that the lender has recourse against either or both of them. So if I transfer my interest in my home to my spouse, it does not affect my duty to keep paying the old mortgage even though it’s no longer my house.
Needless to say, that issue needs to be ironed out. Usually there is a property settlement agreement and it customarily has a clause stating that the spouse in the house will “indemnify and hold the other spouse harmless” from the obligations of that promissory note. Understand that such a clause does nothing to assist the “out of house” spouse in the event that the spouse in the house stops paying. That also means that many lenders look askance at borrowers who come knocking to buy a new house while they still owe money on the residence they left when in search of greener pastures. In practical terms, if I sign an agreement transferring my home to my ex and she later stops paying the mortgage, I can expect the sheriff to come knocking on my door when the lawsuits are filed. And my dopey “indemnification and hold harmless clause” is of no effect as a defense to the suit demanding that I pay the $200,000 still due on my now former home. Reason; my old lender is not bound by your later agreement with my wife.
The clean solution to this dilemma is for the house to be refinanced. A re-fi actually terminates the mortgage my spouse and I signed and substitutes a mortgage in my spouse’s name alone. The promissory note spouse and I used to buy the home long ago is cancelled and the mortgage is recorded as “satisfied.” My spouse walks away with a clear title (my transfer to her) and a note and mortgage in her name alone. If she falls off the wagon and stops paying that new loan, I am clear of any suit because I’m not on the new promissory note.
Alas, as Ken Fineman, a mortgage broker with CrossCountry Mortgage noted in a recent Pennsylvania Bar Association seminar, the refinance business can be tricky. Borrowers tend to think that a refinance is easy if the home has significant equity (market value less mortgage debt), but lenders don’t make money foreclosing on real estate. They make their money by lending to people who have a history of paying their debts on time. Home equity is a benefit but the real keys to a refinance are a solid credit history (of paying bills) and regular income.
Fineman discussed those two elements after noting that each lender has its own underwriting rules governing to whom they will lend and how much. Often the trickier element of the refinance is the income history of the spouse who is getting the home in a divorce transaction. This is also affected by what kind of loan the borrower is seeking. FHA loans impose lower lending standards; however, the cost of the loan will be higher. Non-FHA loans take the opposite approach. Child support and alimony can be credited as income available to pay for the newly refinanced mortgage, but the lender wants to see not just an agreement but 3-6 months of actual compliance with the support/alimony obligation on the part of the person paying.
Payment history has recently been clouded by forbearances related to COVID-19 relief statutes. If there has been a default but it fits within COVID-19 protections, lenders are looking for at least three (3) months of resumed payments before a refinance will move forward. If there has been a bankruptcy, it isn’t usually possible to refinance until four (4) years after the case has closed. If there was a short sale of property, that typically takes three years to “cleanse.” Allowing a property to be exposed to foreclosure usually takes seven (7) years to clear for refinance.
Fineman’s takeaway was that the sooner there is contact with a mortgage broker in a divorce finance transaction the easier the process can be. Mortgage brokers are the “guides” who lead borrowers through the morass of legal and underwriting rules. He noted that there are times when he refers potential clients to consultants who advise clients on how to cleanse bad credit history and improve credit scores. His lamentation was that potential clients often come to him too late in the divorce process. Applicants often arrive with no agreement for support or payment history or with a credit history that could have been repaired but was not.
The truth is that in most cases, it becomes fairly clear early in the divorce whether one party wants the house and whether that aspiration is realistic. The takeaway from this seminar was that once retention of the home becomes clear, it might be time to identify a mortgage broker or lender even though not all the terms of the overall settlement have been resolved. The purpose would be so that support payment histories can be established and credit scores cleansed under the guidance of someone who knows what mortgage underwriters want to see. To do otherwise is to risk that the refinance written so carefully into the property settlement agreement will not “fly” with potential lenders. Bear in mind that few, if any, lenders are going to go to settlement on a refinance until all the terms of the property settlement are concluded and presented to the refi lender for review. However, while we are all admonished to not let the cart go before the horse, this is one instance where parties should consult with lenders about whether the horse will be able to pull the cart when the credit and income histories are fully evaluated.