Before You Do a Cash Out Refinance
There are many cases in a divorce situation where most your assets are tied up in real estate. There may be other assets, but those are usually negated by liabilities. To ensure there is a complete separation of the couple’s financials, the house needs to be addressed up front. To make a clean break from the marriage, you can either sell the property, or one of you can buy the other out of the property with a refinance. For example, if the wife wants to retain the property, she should to refinance the mortgage, in just her name, and completely remove him from the title and all future liability. To give him his portion of the equity, the new loan amount will need to be enough to pay off the old mortgage, his portion of the equity and the closing costs. Most mortgage loan officers would suggest a cash-out refinance, which technically it is.
DON’T DO A CASH-OUT REFINANCE IN THIS SITUATION.
If you do a cash-out refinance, you will pay more than you need to, and have less options for a refinance. You should do what is known as an equity buy-out loan. The problem with the cash-out refinance is that Fannie Mae and Freddie Mac have pricing adjustments to offset the additional risk, and taking cash out of your home is a riskier loan for the lender, and this add-on for a cash-out can be as high as ½% in rate. So instead of a 4.50% rate, the retaining could have a rate as high as 5.00%. This difference is equal to an extra $180 per month in higher payments on a $600,000 mortgage. In other words, and extra $65,000 in additional interest over the life of the loan.
If the Divorce Degree or Marital Settlement Agreement is structured correctly, you would add a paragraph stating that both parties agree to participate in an equity buy-out. Fannie Mae and Freddie Mac both agree that if it is stated in the agreement, and there is no money going to the retaining spouse, they will allow the departing spouse to be paid off as a limited cash-out refinance with no add-on for cash-out. In addition, there will be easier guidelines for loan-to-value, debt-to-income ratios and lower FICO score are possible. An equity buy out is also allowed for rentals and second homes, when a cash-out is not allowed.
One potential concern is…
…that the retaining spouse’s debts may exceed the ratios allowed by Fannie Mae or Freddie Mac. To lower the debt-to-income ratio, I have several techniques I have used in the past that have allowed clients to qualify. Since each divorce is unique, it is suggested that you bring me into the conversation early in the process to ensure that the transaction (and the MSA) is structured correctly and there are no surprises at the end of the divorce. My goal is to inform you of the best way to structure your finances so that you can achieve your real estate goals.