If you are a homeowner, it is normal to feel anxiety about what will happen to the house if you divorce. Will you be the spouse who is able to stay in the house, particularly if you do not want to move your children to another school district or far away from neighbors and friends? Obviously, moving is very stressful.
In my work as a certified divorce financial analyst, also referred to as a "CDFA," one of my primary roles is to help clients answer the eight questions that must be answered to determine if you can keep the house in divorce and whether that decision will improve or perhaps worsen your financial future.
Question #1 - How much is your house worth?
While it sure is convenient and free to check Zillow or Redfin, those values should only be used as a starting point. You may want to hire an appraiser. Or you can ask a local real estate agent to run a comparative market analysis of what similar homes in your community have sold for.
If you are interested in keeping the home but are unsure if there are termites, dry rot, mold, or if the roof needs to be replaced, then it is a good idea to get a home inspection in order to negotiate for a reduced value of the home with your soon-to-be ex-spouse.
Question #2 - How much is owed on the house?
You may know the balance of the primary mortgage, but do not forget to consider a home equity line of credit ("HELOC") or solar loan. Often these need to be paid off when refinancing the primary mortgage as part of a buyout in divorce.
Question #3 - How will you pay your spouse for his or her share of the equity?
Let's assume the house is valued at $1,000,000 and all the encumbrances on the house add up to $400,000. In that case the equity is $600,000 and your spouse's share of the equity is $300,000. Are there enough marital assets (referred to as "community property" in California where I practice) to trade? For example, is there another asset (or combination of assets) in the marital pie that is worth $600,000? It would be a 50/50 split if you kept the house AND took over the responsibility to pay the mortgage and other encumbrances and your spouse kept that other asset in exchange.
If there is not enough marital property, do you have separate property funds that could be used toward the buyout?
Question #4 - Can you qualify to refinance the mortgage in your own name?
I am always surprised how often clients assume they can simply take their spouse's name off the mortgage and just take over responsibility of making the monthly mortgage payments on the current mortgage. This process is called a loan "assumption" and this article explains why it likely is not an option for you.
As I am sure you have heard, the days of sub-3% mortgages are over, at least in the near term as the Federal Reserve has been raising interest rates. This means it is now more expensive to borrow money than it was over the last two decades. This chart from the Federal Reserve demonstrates exactly what I mean. As of December 2023, you'd be lucky to find a 30-year fixed mortage at an interest rate under 7%.
Are you able to show enough monthly income to qualify for a mortgage? Can enough child and/or spousal support be negotiated to add to your employment income? Conversely, if you will be the support payor, can it be negotiated to a low enough number so as to not impair your ability to refinance the mortgage in your name?
What about debt? Do you have a lot of debt or will you have a lot of debt after divorce that could impact your ability to qualify for a mortgage?
Let's go back to the example where the house is worth $1,000,000 and the existing mortgage is $400,000. If there are not enough other assets or cash to do a buyout, can you qualify to refinance the $400,000 mortgage into a $700,000 mortgage so you can pull $300,000 out to pay your spouse in cash? Will you qualify for a $700,000 mortgage?
Question #5 - Are the assets identified for buyout actually worth the same as the equity in the house?
Let's say your spouse has a 401(k) or individual retirement account (IRA) containing pre-tax funds in his or her name and the statement lists the current value at $600,000. It is unlikely that your spouse will agree to keep that account in exchange for the equity in the house. Why? Because $600,000 in pre-tax retirement funds is worth less than $600,000 in equity, particularly in a high income tax state like California. It would not be unreasonable to assume that when your spouse starts taking distributions from that account that his or her combined federal and state tax rate in California would be close to 33% (possibly lower or even higher). So why would he or she agree to keep an account that on an after-tax basis may be worth $400,000 in exchange for you keeping house equity worth $600,000?
Without going into the weeds, it is possible that your house has gone up so much in value that if and when you sell it in the future, you may be on the hook for capital gains tax. Often that tax obligation can be avoided entirely when selling the house as part of of the divorce because in most circumstances you and your spouse (or ex-spouse) can share a $500,000 capital gains exclusion versus when you own the property by yourself and can capture only a $250,000 capital gains exclusion. Sounds esoteric? No, this can add up to real $$$ and if and when we work together I will show you how.
When I work with clients, after-tax estimates of values play a key component in the advice I provide. Who cares how much things are worth on paper if they are going to be worth a lot less than you expected after you have to pay taxes on them? Can you imagine how you would feel if you were counting on receiving $100,000 and ended up with $70,000? You would be enraged, particularly if you had plans for that $100,000! I often recommend my client verify my estimates with a certified public accountant ("CPA").
Question #6 - Is it more expensive to rent than to own a house?
The Tax Cut and Jobs Act of 2017 completely changed the advice you may have received in the past that renting was more expensive than owning. Previously, there were generous tax breaks for paying mortgage interest and property tax. Now that the standard tax deduction is much higher than it used to be (particularly if you will be able to file taxes as "Head of Household" after divorce) and the amount you can deduct for property tax has been capped, it is a lot more attractive to rent than it used to be. You just don't get a lot of tax savings anymore by owning a home with a mortgage and paying property tax (particularly if the value of your home is in the high six figures or greater). I like to educate my clients on this issue by looking at their tax return, pay stub, mortgage statement and property tax statement.
Many people erroneously compare monthly rent with only the principal and interest payment on the mortgage. Don't forget about property tax, homeowner's insurance, HOA dues, utilities, maintenance, landscaping, etc. Renting a home with less square footage than a large house usually requires a significantly lower cash outlay each year. And when you are recovering from divorce, cash flow and an emergency fund are paramount.
You don't want to pay your divorce lawyer their hourly rate to help you with a budget comparison, but that's a perfect assignment for your CDFA who likely charges less than your lawyer or mediator. I work throughout California and particularly in major metro or affluent areas like San Diego, Orange County, Los Angeles, Santa Barbara, San Francisco, and Silicon Valley, my hourly and flat fee rates are significantly lower than your divorce lawyer or mediator.
Question #7 - Are you prepared to be house rich but cash poor?
It's true that just like housing prices, rents have increased too. But when you sell a house and you have equity, you have cash to pay off debts such as credit cards, auto loans, home equity loans, and Parent PLUS loans. Whenever you have debt, you are paying high monthly interest rates to someone else, rather than earning interest and dividends for yourself. Generally, the less debt you have, the faster you will grow wealth as you will be able to save and invest your money.
Once you pay off debt, you may have money left over to use to beef up your monthly retirement fund contributions or invest in a brokerage account.
A lot of my divorcing clients have sold their homes over the past year. They enjoyed a fantastic profit as they sold at a price much higher than they bought. Now they need those funds (typically half a million dollars or more) to generate investment income they can use to help cover their monthly living expenses while they wait a few years until mortage rates come down and they can potentially purchase a home again. In this video I describe one way to do that which carries very little risk of loss of principal.
Question #8 - Are your kids close to graduating from high school and will your spouse agree to continue co-owning the house for a short period of time?
In situations where you and your spouse can cooperate during the divorce negotiations, co-owning the home for a short period of time (with you and the children living in it) can be a possible option. It gives the children time to finish out their high school years before the house is sold. But it also means your spouse may need to rent during that time rather than buy a house for him or herself because a potential down payment will be tied up as equity in the house you are living in.
Laurie Itkin (a.k.a. "The Options Lady") is a financial advisor, wealth manager, and certified divorce financial analyst (CDFA). She serves on the national board of directors for the Association of Divorce Financial Planners. She is also the author of the Amazon best-seller, Every Woman Should Know Her Options: Invest Your Way to Financial Empowerment. Investopedia named Ms. Itkin one of the top 100 most influential financial advisors in the country for two years in a row. As a wealth manager at Coastwise Capital Group, which has received the annual Five Star award for "Best in Client Satisfaction" for 10 years, Ms. Itkin manages the investments of clients' brokerage, trust and retirement accounts. Through her financial consulting company, The Options Lady, she provides divorce-related financial planning and analysis to individuals and couples throughout all stages of the divorce process and has worked on over 400 divorce cases either as a financial neutral or advocate to one spouse. She also speaks at seminars for divorce attorneys and mediators on how to divide equity compensation, including restricted stock units and non-qualified and incentive stock options. Ms. Itkin has appeared as a guest expert on investing and financial aspects of divorce on television, radio and podcasts. She has been quoted in numerous publications including the New York Times, Wall Street Journal, San Diego Union Tribune, Chicago Tribune, Christian Science Monitor, U.S. News and World Reports, Parade, Redbook, and Forbes. Ms. Itkin volunteers as a pro-bono financial planner for the San Diego Financial Literacy Center and Savvy Ladies. She earned her B.S. in economics with a concentration in finance from the Wharton School of the University of Pennsylvania.