If your house is worth less than you owe on it, or if you’re behind in your payments, your divorce is a bit more complicated than others. You can still sell the house or stay in it as co-owners, but you may also have to negotiate—as a team—with your mortgage lender for some kind of change in the terms of your loan. There are a number of options in this situation—none of them great, but all of them giving you at least the knowledge that you’re dealing with your financial problems head on.
In a short sale, you sell your house to a buyer for less than the amount of the mortgage loan, and the bank agrees not to go after you for the difference. For example, if your house is worth $250,000 and your loan balance is $300,000, your buyer pays $250,000 and the bank takes a $50,000 loss. (The only person who makes money on a short sale is the real estate agent.) You walk away with no house—but no debt, either, and you’ve avoided having a foreclosure on your credit record. A short sale isn’t great for your credit, either, but it’s less bad than a foreclosure.
You’re more likely to get a lender to agree to a short sale if you have only one loan on the property. If there’s a second mortgage or a home equity line of credit, it’s a more complicated process, in part because you’ll have to get rid of the secondary loans before a title company will issue title insurance, which your buyer will undoubtedly want.
It’s crucial that you talk to a tax professional before entering into a short sale, because the amount that you are “short” for the mortgage may be considered taxable, especially if you have a second mortgage--any amount forgiven on the second will be taxable income unless you’re considered insolvent at the time of the short sale, meaning that your total debts are greater than your total assets (personal property and equity in real estate). Also, be sure you review the sale agreement to make sure it really provides for you to be off the hook for the shortfall—some unscrupulous lenders may agree to a short sale and then try to sneak language into the agreement saying that you’re responsible for the whole amount, or for homeowners’ association dues or property taxes.
If the lender agrees to modify the terms of your loan, you may be able to keep your house. The lender probably won’t reduce the principal in most cases (unless the bank mishandled your loan from the outset or made errors in a prior modification), but you can get a lower interest rate or an adjustment in the length of the loan so that your monthly payments are reduced. The lender may also agree to put any late payments on the back end of your loan, so that you’re no longer delinquent.
The lender might allow one spouse to be taken off the loan as part of the modification process, though most lenders prefer a refinance for that purpose. So if you don’t have good enough credit for a refinance, you may need to use loan modification as a way to keep the house, even though it stays in both of your names, until the market turns around and you’re able to sell it or your financial situation improves and you can refinance and complete a buyout.
The federal government provides subsidies for some loan modifications, usually for homeowner who are at least 60 days delinquent and meet income qualifications. Each bank has its own criteria for loan modification, so you’ll need to find out what your lender’s rules are.
In this economy, banks and other lenders are dealing with significant losses. In many cases they will lose more if they foreclose on your property or you file for bankruptcy than they will from modifying your loan or absorbing the loss in a short sale. It’s a financial decision for them—often it’s better in the long run for the mortgage lender to keep you in the house, which gives you some leverage.
Foreclosure rules differ quite a bit from state to state. Some states have antideficiency statutes that prohibit lenders from coming after you for a delinquent loan balance, or for property taxes, after the house goes into foreclosure; others leave you on the hook for the balance owed after the property is resold. If you own a condominium that is foreclosed on, you may remain on the hook for homeowners’ association expenses. And if you have a second mortgage or equity line of credit, it’s likely not going to be covered by the antideficiency law.
Foreclosures are either judicial—meaning they are processed in court, you end up with a judgment on your record, and the entire process is public—or nonjudicial, meaning it’s a private transaction between you and the bank, although when the bank puts a “foreclosure sale” sign up outside your house, your privacy is lost. Either way, your credit record will show a foreclosure for seven years.
Many homeowners try to save their homes by using credit cards to pay expenses and even to make house payments. By the time they realize they can’t continue to make house payments, they’re in way over their heads with consumer debt and can’t make those payments either. Bankruptcy can be a way to save your house by getting your consumer debts cancelled or arranging for payments that you can afford.
It’s usually in your best interest to file for bankruptcy jointly with your spouse, because that way you’ll both be freed from all your debts, and you can be sure that there will be no surprises when the bankruptcy and the divorce are completed. In Chapter 13 bankruptcy cases, where you will give the court a plan for paying off some of your debt, you may want to file separately so that it’s clear whose debt is whose after the divorce, but you can have the cases administered together so that you can make the arrangements with creditors consistent with your divorce agreement. If you began your bankruptcy process before you decided to divorce, you should follow through the jointly filed bankruptcy to its conclusion.
It is possible to do both a loan modification and a bankruptcy, and still end up keeping your house. You'll need the help of a lawyer or HUD-approved housing assistance agency. The federal office of Housing and Urban Development (HUD) provides a great deal of useful information on its websites at www.hud.gov and www.makinghomeaffordable.gov. You can find warnings about foreclosure recovery scams, advice about saving your home, and links to free housing counseling and other programs like the Neighborhood Assistance Corporation of America (www.naca.org).
For more information about filing bankruptcy, see Nolo's section on Bankruptcy, Should I File?
Adapted from Nolo's Essential Guide to Divorce, by Emily Doskow.