As a Divorce Lending Professional, I am presented with many unique situations. As we both know, no two divorce cases are ever the same. One of the most frequently asked questions that I am asked is how one party to the divorce can purchase a new primary residence either during the divorce or prior to filing the petition or obtaining a legal separation.
Falling in line with mainstream IRS tax rules, a married couple without a legal separation can have two primary residences. Yes, there is a tax exception to this rule when meeting the requirements for Head of Household; however, I am focusing on mortgage financing rules.
When a married couple is not yet divorced or legally separated, one party may not solely purchase a new home and obtain mortgage financing as a primary residence if they currently own their marital home. This same rule applies even if the ‘buying’ spouse is not on the current mortgage or title of the marital home.
What Are the Options For the Buying Spouse?
The buying spouse will typically need to purchase the new home as an investment property for mortgage financing purposes. Buying a new home as an investment property carries some stricter guidelines than buying a primary residence.
- Down Payment: Typically requires a 20% down payment.
- Interest Rates: Due to what is called Risk Based Pricing, investment properties will carry a slightly higher interest rate than primary residences.
- Insurance Requirements: Insurance requirements may vary by lender; however, landlord insurance with rent loss coverage may be required, which carries a higher premium than a primary residence.
- Reserves: Again, reserve requirements may vary by lender and program; however, can sometimes require 3-6 months reserves for all owned properties.
Once the divorce is finalized and or a legal separation is obtained, the property can then be refinanced to primary residence interest rates and insurance requirements may be modified in alignment with a primary residence as well. Although it may seem quite burdensome for the buying spouse to obtain investment property financing, sometimes we have to be strategic in our planning and understand that things may be modified once other things are finalized.
Home Equity Lines of Credit In a Divorce Situation
Anytime you have a marital home involved in a divorce situation, it is important to identify any lines of credit attached to the home. Many times when clients are asked what the mortgage balances are on the marital home or other jointly owned properties, they often forget about any open equity lines of credit because there may be no outstanding balances.
Even if you obtain a current consumer credit report for your clients, depending on the format of the report an equity line of credit with a zero balance is often overlooked. Many consumer credit reports will group all accounts with zero balances towards the bottom of the credit report whether they are closed or open accounts.
When working out the details on the marital home, don’t stop with just obtaining a legal description of the property. Be sure to pursue actual evidence of ownership and encumbrances, including liens, by order either a full time commitment from a local title company. At the very minimum, I recommend ordering a O&E (Ownership and Encumbrances) report as this will show you how current title is vested which is needed for any transfer of ownership as well as all outstanding liens, mortgages tied to the property.
If you find that there is an open equity line of credit on the property and if there is a balance on it, note that simply paying off the home equity line of credit does NOT close the line of credit. A letter requesting that the line of credit be closed is required. If left open even though it is paid off, both parties are liable for any future balance and either party can use the line of credit—regardless if ownership was transferred to one party.
In First American Title Insurance Company vs. TCF Bank, the appellate court held that the payment of a line of credit loan by a title company in full did not close the line of credit, because the demand must come from the borrower or the credit line is not cancelled. In this case, First American Title Insurance Company paid off the balance of an open line of credit; however, did not request the line of credit be closed with TCF Bank. Afterwards, the line of credit was used by the vacating party and First American Title was held liable for the amount drawn on the unclosed line of credit.
When freezing a line of credit, obtain a letter signed by each of the mortgagors requesting that the line of credit be frozen, and request written acknowledgment from the lender of the bank. If one of the parties refused to cooperate, obtain a court order requiring the reluctant party to sign a written request freezing the account. This may become an issue when the marital home is being transferred to one party and there is not an immediate refinancing of current outstanding mortgages on the property.
When one spouse is retaining the marital home and an open line of credit is overlooked during the divorce process, there could be detrimental effects on the spouse who was awarded the marital home. Any future use of the line of credit, divorced or not, is a lien against the property and must be paid.