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Divorce is rarely easy and often means a lot of difficult decisions. One of the most important decisions is what to do about the house.
In the midst of the heavy emotional and financial turmoil, what you need most is some non-emotional, straightforward, specific information and answers. Once you know how a divorce affects your home, your mortgage and taxes, critical decisions are easier. Neutral, third party information can help you make logical, rather than emotional, decisions.
Probably the first decision is whether you want to continue living in the house. Will the familiar surroundings bring you comfort and emotional security, or unpleasant memories? Do you want to minimize change by staying where you are, or sell your home and move to a new place that offers a new start?
Only you can answer those questions, but there will almost certainly be some financial repercussions to your decision process. What can you afford? Can you manage the old house on your new budget? Is refinancing possible? Or is it better to sell and buy? How much house can you buy on your new budget?
You have 4 basic housing options when in the midst of a divorce:
1. Sell the house now and divide up the proceeds
You’ll have to figure out how to divide the proceeds. In general, that shouldn’t be too complex—the escrow company can distribute the money, after paying off all the obligations on the house and making whatever other payments you’ve agreed to. (For example, you might pay off marital debts with the proceeds of the house sale.) And if one spouse has been making postseparation mortgage payments, that spouse has probably been reducing the principle amount and increasing the equity, which may increase the amount to be divided between the spouses after the closing costs and obligations have been paid. The distribution should be adjusted to account for the paying spouse’s contribution.
Imagine that a year passes between your date of separation and the date your house is sold (not an unusual scenario). During that time, your spouse has made all the mortgage payments, in addition to paying child and spousal support. Each month, $1,700 of the $2,200 payment goes to interest, and $500 goes to principal. That means that over the course of the year, your spouse has reduced the principal on your loan, and thus increased your joint equity in the house, by $6,000—using separate property. Your spouse would be justified in arguing that when the profit from the sale of the house is divided, the division shouldn’t be equal. Instead, your spouse should get back the $6,000 in equity that was earned as the result of the payments during the separation.
2. Buy out your spouse.
What is a "Buyout?"
One way that divorcing spouses deal with the family home is for one spouse to "buyout" the other’s interest. (Other ways are to sell the house or to continue to co-own it.) Often, the custodial parent buys out the noncustodial parent so that the children can stay in the house. The advantages to this are obvious: The house provides continuity and stability for the kids, and you don’t have to sell if market conditions aren’t good.
However, in any buyout, each party bears a risk. The selling spouse may lose out on future appreciation, and the buying spouse may end up feeling the price was too high if the property depreciates in the future. A buyout can also be a financial stretch for the buying spouse.
A buyout can occur over time, with both spouses keeping an interest in the house for a while—whatever agreement you make about a gradual buyout would need to be included in your settlement agreement. But often, the buyout is completed as part of the divorce settlement. The buying spouse either pays money to the selling spouse—usually by refinancing the house and taking out a new mortgage loan—or gives up other marital property worth about as much as the selling spouse’s share. For example, one spouse might keep the house in exchange for giving up his or her share of marital investments and retirement accounts.
3. Have your spouse buy you out.
Determine Who Should Buy the Other Out
One of you may be better able to qualify for a loan. It used to be that a borrower who couldn't verify his or her income could get a “stated income” check loan at the same terms. But this has changed, too. Now, borrowers who can verify their income and have good credit will get a better rate than those whose income can’t be verified.
Alimony and child support can be used as verifiable income. However, if you’re in a cash business, or recently self-employed, that income typically cannot be verified to qualify for a mortgage. Both you and your spouse should speak to a mortgage professional about your ability to qualify. If you are equally able to qualify, then there is nothing to consider. You can go ahead and negotiate the division of property and assets in an equitable fashion. But if one of you is unable to qualify, or able to qualify only for a significantly higher rate, that should be part of the negotiations. If there is a substantial difference in what you can qualify for, you may choose to divide assets through other means, or to simply sell the home and split the proceeds. The bottom line is that you need accurate information about the type and cost of loans that would be available to either of you before you can agree to a buyout.
4. Retain your ownership.
Advantages of Co-ownership
There are pluses and minuses to co-ownership. If the custodial parent can’t afford to buy the other one out, then the obvious advantage is that the kids get to stay in the house anyway, providing an important sense of security and continuity for them. It can make a buyout possible by spreading payments over time.
Risks of Co-ownership
The disadvantages can be pretty significant, though. Because you are both responsible for paying the entire mortgage, a credit report for either of you will show the entire amount of your mortgage. Having such a large debt on your record, especially if you are not living in the house anymore, can make it difficult to get credit for other purposes. You also bear the risk that your spouse will make late mortgage payments that will hurt your credit rating.
There’s also a fair amount of accounting involved. You must decide how you will share the mortgage and upkeep expenses and who can take the mortgage interest deduction. For example, even if you pay equal amounts toward the monthly mortgage, you can agree that one spouse who would benefit more from it gets to take the entire mortgage interest deduction, in exchange for increased support or some other equalizing payment.
It also means that you must continue to be involved with your spouse. Of course, if you are parents, that’s already true, so this may not feel like a big additional burden. But if you anticipate that it will make the emotional disentanglement more difficult, think twice before you agree to this long-term commitment.
You run the additional risk that the spouse not living in the house might have a change of heart later and want (or need) to sell sooner than anticipated. Your settlement agreement should set a specific time that the house can be sold—if it does, the agreement will govern. But anyone who’s really determined to get out of an agreement can make your life miserable in the bargain—for example, by claiming that the agreement was entered into under duress and forcing you into a court fight over that issue. So if you think the decision might not stick, don’t make it in the first place.
If you own the house together for a significant period of time after your divorce becomes final, you also risk losing the important tax benefit of IRS Section 1041, which is the rule that says transfers between spouses as a result of a divorce are not taxable. Section 1041 applies as long as the transfer takes place within a year of the divorce becoming final, or as long as it’s “related to the ending of your marriage,” which means it’s made under a written agreement or order and occurs within six years of the date your divorce becomes final (after six years, you lose the tax benefit no matter what). So make sure you don’t just make a handshake agreement. Make the agreement to keep the house a part of your written settlement agreement, and get the court to approve it so that it becomes a court order.
Finally, consider two important risks. First, what would happen if one spouse died while you were still co-owners? Each of you has the right to leave your share at death. If you’ve agreed that one of you will stay in the house until the kids are a certain age, you could also agree that during that period you’ll each leave your share of the house to the other, so that the resident spouse can continue to stay as you planned. This requires that you both make wills immediately.
The second risk is that one spouse will be sued by creditors or file for bankruptcy. In either of these cases, that spouse’s share could be seized, possibly even resulting in a forced sale. There’s really no way to protect against this, so if you believe it’s a meaningful risk, don’t go the co-ownership route.
Whether you are a home buyer or seller, working with a dynamic, knowledgeable, and ethical professional is essential. Contact us now to make sure you get the best price and the best service throughout the real estate process.
Looking for your perfect real estate match? Finding your dream agent is easy with The Rothman Home Team. Call us today at (613) 862-4455. Or feel free to share our contact information with anyone you know that needs expert help in buying or selling their home in the Ottawa area.
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