How Does Divorce Affect Mortgage Borrowing
Let’s face it: getting a mortgage can be a royal pain in the ass regardless of whether or not you’re recently divorced. Unfortunately, adding a divorce to the picture makes it even more difficult, although not impossible. Here are some things to consider:
What to plan for: By providing your mortgage company with the most accurate and true picture of your circumstances — starting with the loan application — you’re helping them to find the best way to structure your loan for a favorable credit decision. The lender will also look at your divorce decree for any other undisclosed/non-credit report financial obligations such as child support, alimony/spousal support paid or received.
If you receive income in the form of child support or alimony: This income can be used for qualifying for the mortgage, so long as there is a six-month history and the income will continue for the next three years, determined by child support or an alimony agreement detailing the terms of the obligation for the party paying the debt.
If you pay alimony or child support: This reduce your borrowing ability as debts reduce income, and income is needed to offset a mortgage payment.
If you are divorced even as long as 20 years ago: Unfortunately, there is no statute of limitations on mortgage loan underwriting. The full divorce decree will be required no matter how many years you have been divorced.
If you own a house and are on a mortgage with an ex-spouse: As long as the divorce decree awards the other party with the home, and the other party is willing to provide supporting evidence that they make the mortgage payments on that home — by providing 12 months of bank statements and/or canceled checks — the total mortgage payment on that home can be omitted from the decision-making process on your new mortgage, which can improve your ability to qualify.
If you and your ex make the mortgage payment from the same joint bank account and the divorce decree awarded the other party with the property: You are both 50-50 responsible because the money is “co-mingled” funds from the same place to pay the obligation. There is no way to support your position that one person is responsible for making the payment because it’s coming from a joint account.
If the ex-spouse is responsible for making the mortgage that you are also on: Explore the possibility of having the ex-spouse refinance you off the mortgage obligation.
If your ex-spouse is refinancing you off a mortgage loan: A final closing statement called an HUD could be required by the lender you’re working with for procuring your loan to omit the payment from the other house.
If you have a joint consumer credit such as credit cards, installment loans, auto loans or even student loans: Unless you can prove the other party is for responsible for the credit obligation (with 12 months of canceled checks or bank statements), those liabilities will be factored into your ability to qualify.
Tips If You’re Not Yet Divorced
It’s so important to create a marital settlement agreement prior to being divorced. This is a precursor to getting a divorce that could be a great asset in helping you qualify for home financing. Navigating the financial questions that inevitably come up during the separation or divorce can easily be taken care of by having a clear delineation in writing on whose property is whose.
Consumers planning a divorce in the future would also benefit by separating their finances. This means having separate bank accounts, and paying any obligations from these separate accounts. If you are trying to get a mortgage, or will be trying to get a mortgage, consider having a conversation with mortgage professional upfront, who can guide you through the complexities in the underwriting process during a divorce.
Divorce? The 5 Worst Money Mistakes
Written by Guest blogger: Leslie Thompson
During a divorce, a spouse who hasn’t been involved in the family’s finances can often be at a disadvantage during settlement negotiations. That’s why it’s so important for both spouses in the process of dissolving their marriage to understand their post-divorce financial needs and their current financial situation.
The following five items are often overlooked as part of the settlement process, but they’re vital areas to address:
- Cash flow needs
Understanding your need for immediate cash flow is extremely important in determining which assets would be the most beneficial for you to receive in the divorce. If immediate cash flow is a concern, the most valuable assets for you are ones you could sell easily and quickly (so-called liquid accounts), such as stocks, bonds, mutual funds and possibly Roth retirement accounts.
If immediate cash flow is not an issue, a combination of assets with various degrees of liquidity (taxable and retirement plan accounts) will likely be more beneficial long-term.
- Joint liabilities
Just because you agree to split a liability does not mean that the lender will honor your property-settlement agreement. Mortgages will need to be refinanced (if possible), any outstanding tax liabilities on jointly-filed returns will need to be paid and jointly-held credit cards will need to be canceled.
It is important that all liabilities are settled before completing a divorce, either by paying them off or by transferring them to the spouse taking responsibility for the debt.
It is also a good idea to run a credit report to determine if there are any outstanding debts that need to be addressed before settlement.
By securing proof that all liabilities have been settled before the divorce finalization, you’ll avoid an unpleasant surprise when a creditor demands payment from you for a liability that you thought had been settled.
- Taxes on assets
It’s critical to review the tax impact of your investments when evaluating the division of your assets. While two assets or investment accounts may have equal dollar values, their economic value could be vastly different when taxes are factored in.
For example, Roth IRA and Roth 401(k) accounts are funded with after-tax dollars; their future growth and distributions are tax-free. On the other hand, traditional 401(k)s and deductible IRAs are funded with pretax dollars and when you withdraw money from them, taxes will be due on both the amount you contributed and the growth of the investments. As such, Roths have a higher economic value than non-Roth 401(k) or deductible IRAs because they won’t be reduced by future taxes.
If you are younger than 59 and a half, you will pay income tax on withdrawals from non-Roth retirement accounts and possibly a 10% tax penalty. But you can avoid the 10% penalty if the distribution occurs within 12 months following a divorce.
You’ll also want to think about any unrealized capital gains on your taxable investments, since taxes will be due someday. Keep in mind that the first $250,000 of gain from the sale of a principal residence is sheltered from tax.
- Past tax returns
It’s a good idea to review the past three to five years of the tax returns you filed as a married couple. Aside from showing you how much income you two had in a given year, you’ll see whether there are any assets on the settlement agreement or if there are what are known as “tax assets” that need to be considered in the negotiation — such as capital loss carry-forwards, charitable contribution carry-forwards or net-operating losses.
“Tax assets” provide the user a reduction in future taxes and should be considered an asset when splitting the marital estate. But left unresolved, they can cause confusion or errors when filing future tax returns.
- Division of retirement assets
Retirement assets typically represent a large portion of a couple’s net worth and there are special rules to allow for the transfer to be tax-free. You’ll want to make sure the intricacies of these transfers are handled with care.
The divorce decree should specify that any IRA is to be treated as a “transfer incident to divorce” to avoid having the transfer classified as a taxable distribution. Be sure to determine if any basis exists from after-tax contributions made to the IRA — an amount that will be tax-free when distributed. (Consult a tax adviser on this.)
Employer-sponsored retirement plans transfer through a qualified domestic relations order, which requires specific information and approval by the court and plan administrator to allow for a tax-free qualified transfer.
Leslie Thompson is Managing Principal of Spectrum Management Group in Indianapolis. With over 20 years of financial industry experience, she has holds the Chartered Financial Analyst, Certified Divorce Financial Analyst and Certified Public Accountant designations.
*This blog is for information purposes only. Derek Parent and NFM, Inc. accept no liability for its content. Please consult a tax adviser or legal counsel for more information.*