If your house is worth less than you owe on the mortgage or if you're facing a foreclosure, your divorce is a bit more complicated than others when it comes to deciding what to do with the family home. Your options depend on what you want to do with the residence (keep it or give it up) and whether you have equity in the property. You and your soon-to-be-ex might have to work as a team with your loan servicer to sell the house or change the loan terms. Or, under some circumstances, you might decide it's in your best interests to let a foreclosure happen.
A few possibilities to consider include:
Agreeing on one of these options can be difficult during a divorce. But once you understand your alternatives, you can hopefully make a sound financial decision together.
Fortunately, these days, many homeowners have equity in their homes. "Home equity" is that part of the property you actually own. Your equity is calculated by taking your house's value and subtracting the amount you owe on your mortgage and any other liens on the property.
If neither you nor your spouse wants to stay in the home and have equity in the property, your best option is to sell it and split the proceeds. But if you're underwater on the mortgage (your mortgage debt is more than the home's fair market value), you might not be able to sell it for a price that will pay off the loan. In this situation, your lender might agree to a short sale or a deed in lieu of foreclosure.
Again, if you owe more than your home is worth, a short sale might be a viable alternative to consider. In a "short sale," you sell your house to a buyer for less than the amount you owe on your mortgage loan. The benefit to completing a short sale is that you might be able to get the lender to agree not to go after you for the difference, called a "deficiency."
Example. Say your house is worth $250,000, and your loan balance is $300,000. You find a buyer who agrees to pay $250,000 for the home, and, best-case scenario, the lender agrees to take a $50,000 loss. (The only person who'll make any money here is the real estate agent.) In this example, 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 slightly less bad than a foreclosure. Be aware, though, if the lender agrees to forgive the $50,000 deficiency, it will usually report the amount of the canceled debt to you and the IRS on a 1099-C (Cancellation of Debt) form. You then might have to include the forgiven amount as income for federal tax purposes and pay taxes on it unless you qualify for an exception or exclusion. That additional income might also affect your state taxes.
Not all lenders will agree to forgive all or part of the deficiency. In a few states—not many—deficiency judgments aren't allowed after short sales. But the lender usually has the right to pursue a deficiency judgment unless you get an agreement in writing that says the lender waives its right to one.
If you decide to do a short sale and your lender agrees to waive the deficiency, be sure to review the sale agreement carefully to make sure it really says you're completely off the hook. Some lenders will seemingly agree to a short sale and then put language into the agreement saying that you're responsible for all or part of the deficiency.
You're more likely to get a lender to agree to a short sale if you have only one loan on the property. If you have a second mortgage or a home equity line of credit, it's a more complicated process, in part because you'll have to get those lenders to agree to the short sale. The other lienholders will have to agree to accept (and the first mortgage lender will have to agree to give up) a specific amount from the short sale proceeds as an incentive to release their liens. But a junior lienholder can refuse to accept the amount offered, which will prevent the deal from going forward.
If you decide to proceed with a short sale and want to make sure the transaction goes smoothly, especially if you have multiple liens on the property:
A "deed in lieu of foreclosure" is a transaction in which you sign over the title (deed) to your property to the lender, and the lender agrees to release the mortgage securing the loan. Just a couple of states prohibit deficiency judgments after a deed in lieu of foreclosure under specific circumstances. So, similar to a short sale, with a deed in lieu of foreclosure, you need to get the lender to say, in writing, that it agrees to waive any deficiency that remains after the house is sold. (In a deed in lieu of foreclosure, the deficiency is the difference between your total mortgage debt and the property's fair market value.) Otherwise, your lender might come after you for a deficiency judgment sometime down the road.
One benefit to doing a deed in lieu of foreclosure, different from a short sale, is that you don't have to take responsibility for selling your house. Instead, you hand over ownership of the property to the lender, and then the lender sells the home. On the downside, a deed in lieu of foreclosure is just about as bad for your credit as a foreclosure. So, it might not be worth completing a deed in lieu of foreclosure (or a short sale, for that matter) unless the lender agrees to forgive or reduce your deficiency or give you some money to help with your relocation expenses. And your lender most likely won't agree to a deed in lieu of foreclosure if you have more than one mortgage or other liens on the property.
Also, if you have a lot of equity in your home, a deed in lieu of foreclosure is usually a poor choice. You'd be better off by selling the property and paying off the mortgage debt.
If you (or your soon-to-be-ex) want to keep the home, but you'll need a lower mortgage payment, you could apply for a loan modification. In a modification, the lender typically lowers the interest rate and extends the loan's term, which reduces the monthly payment amount. If you're behind in payments, the lender might agree to add the overdue amount to the loan balance as part of a modification.
You may apply for a modification while a divorce is pending, but it's usually better to wait until the divorce is finalized. Here's why: If both you and your spouse both signed the promissory note and mortgage (or deed of trust) when taking out the loan, then you'll both have to sign the modification documents, and you'll each remain responsible for repaying the loan. It might be a tough sell to get your soon-to-be-ex to agree to this plan if they intend on moving out of the property.
But if you try for a modification after the divorce is final and you've been awarded the property, you can apply on your own. It might even be easier for you to qualify for a modification after your divorce is final. One of the eligibility requirements for getting a loan modification is that you must be facing a long-term inability to make your current mortgage payments, referred to as a "financial hardship." Most lenders consider divorce to be a valid financial hardship. Though, getting a loan modification will be dependent to some extent on the terms in the final divorce decree. For example, if the divorce decree says that the spouse who's keeping the home must refinance the loan, you most likely won't be able to get a modification.
Foreclosure procedures differ quite a bit from state to state. Foreclosures are either judicial, meaning they go through court, or nonjudicial, which means the lender carries out a series of out-of-court steps that the state statutes describe. Some states have anti-deficiency statutes protecting homeowners from deficiency judgments after foreclosures. In contrast, other states leave homeowners on the hook for any balance owed after the property is sold at a foreclosure sale.
So, depending on state law and the circumstances, you might be better off letting a foreclosure happen rather than pursuing a short sale or deed in lieu of foreclosure if you can't get your lender to forgive the deficiency as part of either of those transactions. If you won't face a deficiency judgment after a foreclosure—but you will after a short sale or deed in lieu of foreclosure—it might make sense to let a foreclosure go through. Talk to a foreclosure lawyer if you need help deciding whether a foreclosure, short sale, or deed in lieu of foreclosure is in your best interests.
If you have a lot of consumer debt, like credit card debt, and can't make your mortgage payments, filing for bankruptcy could save your house and eliminate or reduce your debt load.
With a Chapter 7 bankruptcy, filers aren't required to pay back any debt, though not everyone qualifies for this kind of bankruptcy. If you're eligible, it might be a good idea to file for Chapter 7 bankruptcy with your spouse jointly. Filing a joint petition has the following benefits:
In a Chapter 13 bankruptcy case, debtors pay their discretionary income to their creditors over the course of a three- to five-year repayment plan. So, if you're thinking about filing a Chapter 13 bankruptcy, it might be a better idea to file individually after the divorce because it takes such a long time to complete.
Also, it's possible to do both a loan modification and either a Chapter 13 bankruptcy or a Chapter 7 bankruptcy and end up keeping your house.
If you're trying to avoid going through a foreclosure during divorce, talk to an attorney who can inform you about the different options that are available and can help you dispose of or retain the property. Also, the U.S. Department of Housing and Urban Development (HUD) provides a lot of helpful information on its website and at www.makinghomeaffordable.gov. You can find warnings about foreclosure recovery scams, tips to avoid foreclosure, and a link to find a HUD-approved housing counselor who can provide you with assistance and advice at no cost.