At the end of the day, divorce is a financial transaction wrapped in complex human emotions. Part of the divorce lawyer’s mission is to try to gently unwrap the emotion so that each party can walk away from a failed relationship with assets that make sense.
Custody of children is the most difficult part of the problem. Each parent tends to see him or herself as the “better” or “more stable” parent. But custody disputes are often meshed with disputes over housing. Almost every parent would agree that the children are the innocent victims of divorce. But things get messy when parents start asking: “Well, why should the children have to move? Isn’t that just adding to the turmoil?”
In an absolute sense, the answer is yes. But our world has very few absolutes and as we shall demonstrate, the market can hurt you badly while you are trying to do what you think is “right by the kids.”
In happier times (2003) our client and his wife bought a home for $300,000. Now things are not so happy and the question becomes how do we unbundle the family assets in the most efficient manner. For the sake of simplicity, let’s assume a 50/50 split of the assets even though there is no presumption of any asset split in a Pennsylvania divorce matter. When they bought the house, like most folks, they took a 30 year mortgage for $270,000. In 2015, with houses in the neighborhood selling for $490,000, they decided they would take advantage of lower rates and refinance to a fifteen year mortgage. The new re-fi debt was then $215,000.
Today, as we all know, home values have “popped” and the market surveys indicate the house is worth an additional $60,000. Part of the reason for the “pop” is that rates declined a lot. Our couple would have refinanced at about 3.77% in 2015. By July 2020 rates had declined to 3%. They bottomed in January 2021 at 2.74%. They climbed back a bit toward the end of 2021 ending in December at 3.1%.
Friday’s Wall Street Journal (4/1) reports that “Mortgage Rates Leap to Highest Since 2018.” The article reports that mortgage bankers say they are seeing no let up in applications. Realtors are reporting that in most markets the inventory is painfully thin. But Freddie Mac reported on Thursday that the average rate for the 30 year conventional fixed mortgage was 4.67%. So, what was 3.1% in December is now 4.67%. Now that’s inflation. In December, gas was $3.40. Today, I see $4.29. If gas prices paralleled mortgage rates, a gallon would be $5.10.
Now let’s get back to our couple in their now $550,000 home. The mortgage is about $130,000. Most counties in Pennsylvania take 7% from the fair market value to adjust for a six percent sales commission and a 1% transfer tax. On $550,000 that’s a $38,000 adjustment. Subtract that together with the $130,000 balance and the “equity” in the home is $382,000. If one party buys the other out at 50/50, the buying party will assume the $130,000 mortgage balance and pay the other party half the $382,000 equity. That payoff is $191,000.
In our case, it is clear that there are only two options. Only one party has the income to shoulder the $130,000 mortgage and the $191,000 needed to pay off the other spouse. Four months ago, we would have told that spouse to refinance the entire house over 15 or 30 years and get a new 3.1% mortgage for $321,000. Today, just ninety days later, it makes no sense to pay off a 3.77% mortgage and roll that $130,000 into a 4.67% mortgage. So, we are advising the client to keep the old mortgage and add a $191,000 home equity to buy-out his spouse’s interest.
Now let’s look at this in terms we all understand. What’s the monthly “nut?” In the end we buy houses based on affordability and the hope/expectation of appreciation over time. If our client had done the transaction in December, he would have borrowed $321,000 over 30 years at 3.1%. His mortgage and interest payment would have been $1,371 a month. Today, his best option is to keep his 3.77% 15 year mortgage at $1565 per month and add the $191,000 as a home equity loan. That loan at today’s rates will be $987 a month for thirty years. For the next eight years he will pay $2,552 a month. His redemption will come when the 15 year is paid off in 2030 and he will be left with $987 a month for 22 more years.
There’s a child and no doubt the couple would like to help that child with college. But during those golden college years, the mortgage is $1,000 a month higher than it is today. It could have been $194 cheaper if we could roll the clock back to late 2021.
There’s other risks to discuss. Home price deflation. We have had it before. In the late 1990s and in 2009-2010 during the great deflation. Houses weren’t moving and bottom feeders were offering low ball bids. There is another force at work as well. In our matter, the house is on a 4 acre lot. It’s 3,500 square feet. When it was built in 1998 it was the quintessential upscale house. But 4 acres? And while 3,500 square feet remains popular the trend seems to be headed down for the first time in terms of how much space people want. Last, but not least, is what can be termed “buyer’s affordability.” Assume a year from now 30 year mortgages are 5.5% and our client is transferred or otherwise needs to sell (to contribute to college, for example). If he puts the property out at $550,000 and his buyer does a 30 year finance of 95% at 5.5%, that buyer is going to pay $3,000 a month + $700 in real estate taxes. So, toss in some casualty insurance and the prospective buyer is in for a coupon that says pay almost $4,000 a month for housing. Then mow your 4 acre yard. The point is that our client missed out on a chance to buy out the spouse and keep housing costs with taxes and insurance close to $2,000. The person he sells to will have to pay double that amount. That buyer may be saying he won’t go above $500,000 because he can’t afford that monthly payment and the client will have to eat a $50,000 loss.
It’s emotional. Yes, it would be nice to keep the children in the house they grew up in. But the joy of that same bedroom is tempered by the sad countenance of a parent who can’t really afford or is losing hard money keeping that bedroom. As a former client who moved more than a dozen times during her childhood put it; “It’s never easy to move, but you get used to it.”