Of the many thorny issues that need to be worked out in a divorce, how to handle your shared mortgage is a big one. Some divorcing couples may simply agree to sell their home, divide the proceeds and start fresh somewhere new.
But in many cases, one spouse will remain in the home and the other will need to relinquish their ownership. This is where options like refinancing or mortgage assumption, which can allow one spouse to become the sole mortgage holder, come into play.
Is it better to refinance with a new loan or to assume the existing mortgage? Here’s a look at how these options differ, their qualification requirements, and their pros and cons.
[Read: Best Mortgage Lenders]
What Is Mortgage Refinancing?
Refinancing your mortgage involves taking out a new loan to replace your existing loan — with a new interest rate and terms and a closing process similar to your original mortgage.
Borrowers typically do this to secure a lower interest rate, lower their monthly payment by extending the loan term, or switch between fixed and adjustable rates. But refinancing also provides an opportunity to add or drop someone’s name from the mortgage.
Generally, refinancing is a good idea if the result is a better interest rate, loan term or monthly payment, but given interest-rate trends in recent years, you really want to crunch those numbers. While mortgage rates have trended downward over the past year, they are still around their highest levels since 2007. So if your mortgage is less than 15 years old, odds are your existing rate is lower than what you’d get today.
“In the current mortgage interest environment … it is nearly always better to assume the mortgage rather than refinance,” says Julia Rueschemeyer, a Massachusetts-based attorney specializing in divorce mediation. “Refinancing involves thousands of dollars in transaction fees and higher interest rates.”
Let’s say a couple took out a 30-year mortgage in 2018 for $250,000 with a fixed 3.75% interest rate. Their monthly payment (principal and interest only) has been $1,158 and, after six years of payments, their remaining balance is $219,650. But now they are getting a divorce, and one of them will refinance to become the sole mortgage holder.
A new 30-year mortgage on their remaining balance at the current average rate of 6.4% would result in a higher monthly payment of $1,374 and an additional six years of loan payments to make.
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“Beyond the increase in monthly payment, the overall total cost of the mortgage will skyrocket,” Rueschemeyer says.
With the original loan, making only regular monthly payments, the couple would have paid a total of $416,804 after the 30-year loan term. With the refinanced loan, the total would be $494,613 over the life of the loan, in addition to the payments that were made for the prior six years on the original loan.
Mortgage Refinance Pros and Cons
Pros
— You can add or drop someone’s name from the mortgage.
— You could potentially get a more affordable monthly payment.
— Cash-out refinance could provide an opportunity to split some of the equity you’ve built as a couple.
Cons
— Refinancing will likely result in a higher interest rate in the current environment.
— Starting over with a new 30-year loan could mean more years in debt.
— You’ll likely pay thousands of dollars in closing costs on the new loan.
[Read: Best Mortgage Refinance Lenders.]
What Is Mortgage Assumption?
Generally, mortgage assumption is an arrangement that allows the buyer of a home to assume the remaining balance of the seller’s mortgage, and that includes keeping the existing loan terms and interest rate. In the case of divorcing couples, this can enable one spouse to assume sole responsibility for the mortgage without the need for a new loan.
“This arrangement can be advantageous, especially in high-interest-rate environments, because the buyer could inherit a lower interest rate than what’s currently available,” says Brian Quigley, founder of Colorado-based mortgage brokerage Beacon Lending.
Assuming a mortgage can also be a lot less costly than going through the refinance closing process. But while mortgage assumption may be more advantageous in the current rate environment, there can also be downsides to these arrangements.
Mortgage Assumption Pros and Cons
Pros
— You can continue paying your existing mortgage without getting a new loan.
— You’ll pay less to assume a mortgage than you would to refinance.
— You can keep your existing interest rate, which may be much lower than what’s available today.
Cons
— The spouse assuming the mortgage could be asked to buy out the other’s equity.
— VA loan holders could lose their entitlement if the mortgage is assumed by someone who otherwise would not qualify for a VA loan.
— The spouse leaving the mortgage could be surrendering home equity they helped build.
Keep in mind that the spouse assuming the mortgage will need to meet all of the lender’s income and credit requirements for being the sole mortgage holder. And assumption won’t be an option for everyone, as only certain types of mortgages are assumable.
What Types of Mortgages Are Assumable?
The majority of mortgages are not assumable. In most cases, conventional mortgages cannot be assumed, though some may have assumption clauses for specific circumstances like the death of a spouse.
However, the more popular government-backed mortgages typically come with assumption clauses that could enable one spouse to become the sole mortgage holder. These loans make up about one-fifth of U.S. mortgages, according to a U.S. News analysis of Federal Housing Finance Agency data.
These types of mortgages tend to be assumable:
— FHA loans. Federal Housing Authority loans are assumable as long as the buyer meets the standard FHA loan requirements, such as having a minimum credit score of 620 (or 580 under certain circumstances) and a debt-to-income ratio no higher than 43% (or 50% under certain circumstances.)
— VA loans. Mortgages backed by the Department of Veterans Affairs are assumable, but the VA loan entitlement transfers with the loan. Also, the assumer of the mortgage will need to meet the lender’s income and credit requirements for a VA loan.
— USDA loans. To assume a U.S. Department of Agriculture loan, you must get approval from the USDA and the lender. The USDA requires a minimum credit score of 640 to assume a mortgage, and the loan must be in good standing. You must also meet standard program requirements, such as having household income that does not exceed 115% of the area median and a DTI ratio of no more than 41%.
If you’re unsure whether your mortgage qualifies, your lender can tell you. Rueschemeyer suggests checking with your lender “specifically to see if they allow an ‘assumption of the note’ or ‘amendment to the note.'”
[Calculate: Use Our Free Mortgage Calculator to Estimate Your Monthly Payments.]
Alternatives to Refinancing and Mortgage Assumption
If refinancing or assumption aren’t right for your situation, rest assured there are some alternative options divorcing couples can consider.
“They could sell the home and split the proceeds, which is often the simplest option,” says Quigley. “Or they could consider a buyout where one spouse pays the other for their share of equity.”
You could also include terms in your divorce agreement that allow one spouse to continue living in the home for a set period — say, until your children graduate from high school — without taking the other off the deed or mortgage.
“This can allow a spouse with children to keep the house even when they don’t have enough money to buy out the other spouse at the time of divorce or enough income to refinance the house into their name,” Rueschemeyer says.
Rueschemeyer says in some cases a couple may plan for a delayed buyout, giving the spouse who is keeping the house time to buy out the other’s equity, either in a lump sum or predetermined payment plan.
Which Option is Best For You?
Carefully consider your options when deciding whether to pursue a mortgage assumption or refinance after a divorce. While mortgage assumption is likely the simplest and least costly option in today’s environment, the decision comes down to what works best for your circumstances.
“Divorcing couples need to look at who will keep the home, how they’ll manage payments and what the best financial option is for both parties,” Quigley says. “Consulting a financial advisor can help you decide which approach aligns best with each person’s long-term goals and financial standing.”
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Mortgage Assumption vs. Refinance After Divorce: What You Should Know originally appeared on usnews.com
