By: Joseph Goldy, CFP®
I recently read an interesting article in the Wall Street Journal about how anyone with a low-rate mortgage may not realize the actual value of their asset. In the current world of 7%-8% mortgage rates, anybody with a sub-4% mortgage rate owns a precious asset. Viewing a loan that needs to be repaid as an asset is counterintuitive. But any loan from a bank at 3.5% when rates on Treasury Bills and CDs are at 5% has significant value. By the Journal author's estimate, some $1 trillion in value has passed from banks and bondholders to homeowners.
However, the current interest rate environment presents some unique challenges for people going through a divorce.
For example, if you're the party keeping the home, depending on your equitable distribution settlement, you may need to refinance to remove your ex-spouse from the mortgage. Although some people may choose to stay on the mortgage together, this is not common, and most parties agree to either sell the marital home or retain the property.
For the person remaining on the mortgage, a higher mortgage rate can seriously impact their cash flow. Let's look at a hypothetical couple who purchased their home ten years ago with the following details:
Original Mortgage
Mortgage amount: $350,000
Interest rate: 3.50%
Loan term: 30 years
Monthly principal and interest amount: $1,571
New Mortgage after Refinance
Remaining mortgage balance: $270,944
Interest rate: 7.50%
Remaining loan term: 20 years
Monthly principal and interest: $2,183
Assuming the person keeping the home refinances into a 20-year mortgage to keep the term the same, they would now pay $611 more monthly to remain in the house! Over the remaining 20 years, this additional amount would total an extra $146,748 in interest. Even if the spouse keeping the home decides to refinance out to a new 30-year loan term instead of 20, it would still be $323 more a month or $3,876 more per year.
This increased expense is significant for many people who have just gone through a divorce. In addition to the increase in the monthly mortgage amount, there are also refinancing closing costs from the lender that must be paid.
Alternatives to Remove an Ex-Spouse
Although some people can work out an agreement where both parties stay on the mortgage, this is not ideal. Divorced couples remaining on the mortgage can create friction since both are now forced to maintain the home and ensure the mortgage is paid on time; otherwise, it can hurt both parties' credit.
For some couples who have gone through a difficult divorce, having to all of a sudden be amicable with each other is not a realistic expectation. Considering the damage to someone's credit should mortgage payments be missed or the home fall into foreclosure, this situation is not feasible for many people going through a divorce.
Two alternatives to refinancing some lenders offer are loan modification or loan assumption.
With a loan modification, you are changing the actual terms of your mortgage. This strategy is commonly done to help someone going through a financial hardship, but a lender may allow a loan modification for reasons of divorce or legal separation. The benefit of a loan modification is you are removing one party from the mortgage while not changing the interest rate for the remaining spouse.
Similarly, a loan assumption allows one of the two parties to remain on the mortgage, with one being removed. An ex-spouse is simply removed from the note and no longer considered a borrower responsible for paying back the loan.
With a loan assumption, the spouse being removed from the mortgage will request a release of liability, which releases the obligation to repay the loan if an ex-spouse fails to make payments. Loan assumptions typically cost one percent of the loan amount plus administrative fees.
The above two options are good alternatives to a refinance in the current interest rate environment since, in both scenarios, your mortgage interest rate is not changing. Unfortunately, these options are not available from all lenders.
Ultimately, there are several good reasons to keep the marital home after a divorce, especially if children are involved. Emotional stability, consistency for the kids, and not selling in a potentially volatile market are all legitimate reasons for one spouse to hang onto the home. However, it is critical to understand the additional cost and its impact on cash flow while keeping the marital home.
Joseph Goldy, CFP®, is a wealth advisor and CERTIFIED FINANCIAL PLANNER™ at Highland Financial Advisors, LLC, a fee-only fiduciary wealth advisory firm based in Wayne, New Jersey.
Joe specializes in working with newly independent women because of divorce or losing a spouse. He understands firsthand the value of having a clear financial picture pre- and post-divorce and a plan to restate goals as a single person. When he is not helping clients, Joe enjoys spending time with his two sons outdoors and volunteering to help raise money for Type 1 diabetes organizations.