Underwater Mortgages and Divorce
What can you do if you're getting divorced and need to decide who gets the house - which has an underwater mortgage?
There are a number of options here, but unfortunately, none of them are particularly easy or attractive.
When a divorce occurs and the couple shares a home with a mortgage, one of two things typically occurs. The first is that one person gets the home in exchange for financial considerations in the divorce agreement, and the mortgage is refinanced into that person's name alone. The other is that the house is sold, and the proceeds are divided among the two according to the divorce agreement.
That's how it works when there's equity in the house. If the mortgage is underwater, though, the house is a liability, not an asset, and things get much stickier. At the same time, the basic options are the same 1) get rid of the house or 2) one person gets it. Here are some of the ways to do that.
If you can do it, this is probably the best-case scenario. There are programs that allow you to refinance an underwater mortgage, most specifically, the Home Affordable Refinance Program (HARP), which is due to announce new, more relaxed guidelines Nov. 15. If you can, refinance the mortgage under the name of the party keeping the house, and make some other arrangements in the divorce decree to reflect the financial liability he or she is assuming.
For this to work, the person getting the house needs to have enough financial resources to continue the mortgage on their own. In addition, some lenders may decline to do a HARP refinance if one person is coming off the mortgage, although it is permitted under the program's basic guidelines.
Another option is a cash-in refinance, where one or both of the divorcing parties contribute money toward paying down the mortgage balance far enough that it can be refinanced. Again, these contributions need to be factored into the overall divorce settlement.
This is where you try to get the lender to agree to let the home be sold for less than balance owed on the mortgage. Usually, lenders are reluctant to do this unless it's apparent the mortgage holder will be unable to continue making mortgage payments. A divorce may qualify if both parties' incomes were contributing toward the mortgage payments.
One of the downsides of a short sale is that it does a lot of damage to your credit, since it goes on both of your records as a settled debt not paid in full. In addition, some lenders may still refuse to grant a short sale even though you're divorcing, preferring to still hold both parties liable even though they are no longer married.
If you're well underwater, this may make the most economic sense, even though it will savage your credit rating for seven years. Many divorcing couples simply choose to mail the keys back to the bank and abandon the property, a process known in the industry as "jingle mail."
In some cases, one of the ex-spouses will continue to live in the property after both have ceased making mortgage payments, simply waiting for the bank to eventually reclaim it. Since some foreclosures are taking in excess of two years these days, this can be a financial benefit to the party staying in the property. The downside, particularly for the non-occupying ex-spouse, is that it's going to take that much longer for the blot to come off their credit, since it extends the foreclosure process.
On the upside, if you remarry soon after, you may be able to buy another home fairly quickly using your new spouse's unblemished credit, though you may not be able to count your income toward qualifying for the loan.
On the downside, foreclosure may not get you off the hook if you have a second mortgage on the property. Typically, a lender's only recourse in a foreclosure is whatever it can recover from the sale of the property. But if the second mortgage holder gets no payment from the property sale (since it all went to the primary mortgage holder), in some states that means its claim is still valid and it can still seek reimbursement, perhaps years.
Deed in lieu of foreclosure
This is a somewhat better option than "jingle mail," if your lender will accept it. You tell your lender you're getting divorced, won't be able to afford the home anymore and ask to simply sign the deed to the property back over to them.
This gets you clear of the house without any further liability, and will have less impact on your credit than a foreclosure will - and you may be able to negotiate how the lender will report it to the credit bureaus. For the lender, the attraction is that they avoid the cost of foreclosure and get the property in better shape than a typical foreclosure, which is often in neglected condition. You also start rebuilding your credit sooner than if you let the property go straight through the foreclosure process.
This doesn't mean not getting a divorce, it means that the two of you continue to occupy the same house and pursue separate lives until such time as you can refinance, sell the home or come to some other resolution. This isn't as strange as it sounds - in the current economy, many divorced couples are doing this when they can't afford any other alternative. It goes without saying that this type of arrangement only works if the split is fairly amicable.
Divorce is usually messy and having to deal with a financial liability like an underwater mortgage makes it even messier. It's a difficult situation and one you'll need a competent professional help to address, so don't proceed without talking things through with your legal and financial advisors.