Refinancing or Buying Out Your Spouse: Insights from a Mortgage Lender
Get the inside story on what to do with your home and your mortgage when you divorce.
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If you are getting a divorce and you own your home, you'll have some important decisions to make. Will you sell the house and divide the proceeds? Or will you keep the house for one spouse to live in? If one spouse keeps the house, will that spouse buy the other out? Will the spouse who keeps the house refinance the mortgage?
(See Divorce & The Marital Home for more information on this subject.)
If you need to refinance your mortgage to buy out your ex, there are some things you'll need to know. The mortgage industry has undergone dramatic changes since the housing bubble burst and the economy took a nose dive. Even if you were approved easily in the past, you may find your loan application undergoing more scrutiny -- and taking much more time -- than before. Here are some tips that will help you find the right financing package at the cheapest possible cost.
Consider How the Amount You Borrow Affects Your Interest Rate
In the past, buyers got roughly the same interest rate whether they put down 5%, 10%, or 30% of the purchase price. In a refinance, they'd get the same rate whether they borrowed 50% of the home’s value or 80%. This is no longer the case. Fannie Mae and Freddie Mac, the two largest institutional purchasers of residential mortgages, now apply “risk-based pricing” to all conventional mortgage loans. Even with the government takeover of these two institutions, risk-based pricing remains. This means that the interest rate you have to pay will depend on how much you borrow as a percentage of your home’s value.
For example, let's say your home is worth $200,000, and you still owe $100,000 on your mortgage. You want to keep the house, but you and your spouse have agreed to divide the equity equally. This means your ex is entitled to half of the remaining equity, or $50,000. Therefore, you would have to borrow $150,000 to pay off your existing loan and buy out your ex. However, you would be borrowing at 75% "loan to value"; that is, you are borrowing 75% of the value of the house. Due to risk-based pricing, your rate could be anywhere from 1/8% to ¼% higher than it would be at 70% financing. Risk-based pricing also factors into your credit score. Therefore, if you need to buy out your spouse, you should talk to an experienced mortgage professional who can tell you whether you’d save money on your mortgage by staying within a specific loan-to-value ratio. If there is a significant difference in rate, it might make sense to borrow less and come up with the additional amount by taking money from savings or some other asset, if possible. Whatever you decide to do, make sure you understand the connection between loan-to-value ratios and interest rates. It could help you save thousands of dollars over the life of your loan.
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.
Understand the Difference between Automated and Manual Underwriting
In the 1980’s, mortgage loans were manually underwritten (evaluated as to the eligibility and credit-worthiness of the borrower). An underwriter (an actual human being) would review the borrower's credit history, income, and assets, as well as the appraisal of the property that would secure the mortgage. Once they reviewed the file, they would issue a credit decision (either an approval or a declination).
In the 1990’s, however, automated underwriting became prevalent. An underwriter, or more likely, a processor, would enter the borrower's information into a computer and click “submit.” Afew seconds later, the computer would generate a response. The underwriting decision (approval or declination) relies heavily on credit score. Typically, a borrower with a score of less than 620, or who had made late mortgage payments or other late payments in the past year, would not go through automated underwriting (meaning the loan would not be approved).
A lot of people who go through a divorce find it hard to stay on top of their bills. You may be expecting temporary support payments that are slow in coming; you and your spouse may have had a misunderstanding -- or a disagreement -- about who will be responsible for paying which bills; you may find it difficult to stretch the income that once supported one household to support two; or you may have moved out and not even seen the bills. For a variety of reasons, many people find it difficult to maintain perfect credit when they go through a divorce.
If your credit history shows late payments, you might be better served by old-fashioned, manual underwriting. Most lenders will allow a manual underwrite at the same terms (meaning you still get the same rate as if your loan went through automated underwriting). Manual underwriting allows you to present letters of explanation as to why bills were paid late. Going through a divorce is a perfectly valid reason for late payments (as long as your credit history is usually good). With manual underwriting, you get to present your case to an actual human being, instead of a computer. A computer can’t think, nor can it feel. If you have credit issues resulting from your divorce, you need a human being who can review your overall credit profile and make a common sense underwriting decision.
The mortgage industry has changed, and will continue to go through changes. If you need to refinance to buy out your spouse, you need to be aware of these changes so you can make smart financial decisions. Take the time to select a mortgage professional who understands what you’re going through and what you need to accomplish. Divorce is a difficult time, emotionally and financially. More than anything, you need accurate, reliable information so you can get a good rate, buy out your ex, and move on with your life.