Divorce lawyers are not real estate agents and we are not mortgage brokers. But in any given year we move a lot of residential real estate as splitting couples either cash out or buy one another out of the old homestead.
The Wall Street Journal reported on January 21 that residential home sales reached a 15 year high in 2021 and that demand is expected to remain great well into 2022. That is, unless the Federal Reserve and the lending markets decide to poop the party. And indications are that this may be underway.
In early 2008 mortgage rates hovered around 6% for conventional 30 year financing. The residential realty market was crazed and lenders were closing on deals without any income verification of substance. Then the market cracked, first with Bear Stearns failing (3/2008) and then Lehman Brothers (9/2008). In an effort to juice the economy the Federal Reserve dropped its discount rate (loans to banks) to zero trying to keep the economy alive. It worked and we eluded what could have been an economic collapse by Spring, 2009. But, because we love cheap money, the Fed never took the analgesic away, even after the economy soared. When the market was in free fall, the S&P 500 was at 940 but you still paid 5% for a mortgage. Today the S&P 500 is at 4,400 but a 30 year mortgage only costs 3.6%. So, you can afford a big fancy house because rates are so low. And that is what is driving the market today.
The biggest winners have been the people with houses in the $300-500,000 range. Some have seen their homes increase by $100,000 or more in the past 24 months. How does this affect the divorce world.? Let’s assume a 50/50 split of a house with $400,000 worth of equity. If I represent the spouse who wants to keep the house he/she needs to refinance and give the departing spouse $200,000. That number would have been $150,000 two years ago but who cares? I’m refinancing at 3.6%. Life is good.
Well, maybe. Here’s the problem that interest rates and real estate taxes can cause. I pay off the ex and now I still owe 400,000. $200,000 of that was my old mortgage and $200,000 is the blood money I paid the ex to keep the house. The good news is that any prospective increase is all mine now because I bought the ex out of her interest.
Alas, there is the problem. What really drives real estate prices is affordability. As interest rates rise, fewer and fewer people can afford your house. And when they can’t afford your house, they will pay/bid less for it.
A year ago, residential mortgage rates on a 30 year fixed basis were 2.83%. Today they are 3.59%. As a home buyer, a 30 year mortgage for $400,000 that would cost $2,327 a month in January 2021 now has the same buyer paying $2,516 for the same package. That’s $189 a month more for the next 30 years. But let’s assume mortgages go back to a normal 6%. That same $400,000 mortgage will cost $3,169 a month. A buyer can address $189 a month by cutting the cable cord. But $843 a month for 30 years is real money. $300,000 more over 30 years.
It doesn’t stop there. Spouses who sell to each other may or may not draw the attention of the local county, township and school district authorities. If you buy the home that was being taxed on a $350,000 value and you pay $500,000, you should expect that the $5,000 real estate tax bill will go to $7,150. That’s another $150 a month. When you go to sell, that’s the world your prospective buyers may face.
Here’s what divorce lawyers are facing. One spouse wants to keep the house. It means a re-fi and an increase in debt. It may also mean a visit from the local tax authorities. These problems may seem minor if you are adding $200,000 of buyout debt at 3.6% over 30 years. But the real question is whether you can still get the value you are paying today to keep your home in a market where interest rates are rising and crowding buyers out of the market.
It’s not an easy choice. You can always sell but then where do you live? Even if you downsize to a cheaper home you are still paying a premium. In fact the cheaper homes have had the biggest increases in value.
We like to end this kind of essay with the “right choice” answer. Unfortunately, there really isn’t one. But if you are keeping the old homestead for emotional reasons, you need to ask yourself, what are the real prospects to retain home value or see it increase when you are doing a transaction in what is undeniably a “hot” market.
Imbedded in this is forecasting the return you get on an investment, whether a house or the “market”. Money in real estate is money not invested in equities. As the investment community likes to tell us in the small print; past performance is not an indicator of future results. But in this writer’s suburban Philadelphia neighborhood the past 13 years has brought a 34% increase in home values while an S&P index fund garnered 10x that return (368%) in the same period.