Refinancing or Buying Out Your Spouse -- Insights from a Mortgage Lender

If you need to refinance to buy out an ex-spouse, here are some things you should know.

The mortgage industry has undergone dramatic changes over the past year. Even if you were approved easily in the past, you may find your loan application undergoing more scrutiny than before. Here are some tips that will help you find the right financing package at the cheapest possible cost:

Evaluate different loan amounts and the impact on rates

It used to be that when you were buying a house, you would get the same rate whether you put down 5%, 10%, or 30%. In a refinance, you’d get the same rate if you borrowed 50% of the home’s value or 80%. Not anymore. 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 there are different rates based on how much you borrow as a percentage of your home’s value. 

For example, if you owed $100,000 on your mortgage, and your home was worth $200,000, and you agreed to a 50/50 distribution of equity, your ex-spouse would be 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 get enough to buy out your ex. However, then you would be borrowing at 75% loan-to-value ($150,000 loan amount divided by the $200,000 value). “Risk based pricing” means that at 75% loan-to-value, your rate could be anywhere from 1/8% to ¼% higher than it would be at 70% financing (risk based pricing also factors in credit score). Therefore, if you need to buy out your ex-spouse, talk to an experienced mortgage professional who can tell you if you’d save money on your mortgage by staying within a specific loan-to-value. If there is a significant difference in rate, it might make sense to stay within 70% loan-to-value, for example, and come up with the additional amount by taking money from savings or some other asset, if possible. Whatever you do, make sure you understand the connection between loan-to-value and interest rates. It could help you save thousands of dollars over the life of your loan.

Determine who should buy the other person out

One of you may be better able to qualify. It used to be that if you were not able to verify your income, doing a “stated income” check loan was widely available at the same terms. This too has changed. Now, if you are able to verify your income and have good credit, you will get a better rate than if your income can’t be verified. Alimony and child support can be used as verifiable income, but 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 ex-spouse should speak to a mortgage professional about your ability to qualify.  If you are equally able to qualify, then there is no issue. 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 if you would qualify through a stated income check program with a significantly higher rate, that’s something you need to know and use in your negotiations.  If there is a substantial difference in what you can qualify for, you may choose to divide assets through other means, or simply sell the home and split the proceeds. Bottom line – you need information about what’s available before you can agree to a buyout.

Understand the difference between automated and manual underwriting

In the 1980’s, mortgage loans were manually underwritten. An underwriter (an actual human being) would review your credit history, income, assets, and the appraisal on the property that would secure the mortgage. Once they reviewed your file, they would issue a credit decision (either an approval or a declination). In the 1990’s, automated underwriting became prevalent. An underwriter, or more likely, a processor, would enter your information into a computer, click “submit,” and a few seconds later, the computer would generate a response. The underwriting decision (approval or declination) relies heavily on credit score. Typically, if your score is less than 620, or if you have had mortgage late payments or other late payments in the past year, your loan will not go through automated underwriting (meaning you 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 which are slow in coming; you may have moved out and don’t see the bills. For whatever reason, 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 with 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 will allow you to present letters of explanation as to why bills were paid late. Going through a divorce is a perfectly valid reason why your payments were not made on time (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, and it can’t 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 ex-spouse, you need to be aware of these changes so you can make smart financial decisions. Take 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.