Refinancing Guidelines in the Divorce Settlement Process
Many times during a divorce settlement the main goal is to help the divorcing couple get out of their current situations and we forget to realize how the divorce settlement will affect their ability to secure financing in the future. In order for the divorcing clients to be successful post decree and have the ability to execute any divorce settlement agreement requirements, i.e., refinancing one spouse off of current mortgage, qualifying for a new home purchase using maintenance as qualifying income, etc.
It is imperative to involve your mortgage team member during the early stages of the divorce and not just refer your divorcing clients to them post decree. There are so many more moving parts during a divorce loan process when you have support as income, division of assets, joint liabilities, and more that require the expertise of a Certified Divorce Lending Professional.
Let’s look at some of the moving pieces of mortgage planning and the divorce settlement process are related and gain a better understanding of how important it is to begin the mortgage planning process during the settlement process rather than once the marital settlement agreement is finalized and all parties must deal with the cards that are dealt.
Timing of Filing Divorce
Probably the most common question I am asked from my divorcing clients and partners is ‘When can the refinance be done – do I have to wait to purchase a new home – and more’ – all relating to the timing of actually filing for the divorce. It is important to understand that once the petition for divorce has been filed, any mortgage financing will need to wait to close/finalize until the final divorce judgment has been entered and signed by the judge or temporary orders are in place that meet mortgage guidelines.
Income vs. Qualifying Income
Often times in a divorce and mortgage situation there are various types of income to consider: Employment Income; Alimony/Maintenance Income; Unallocated Maintenance Income; Child Support Income; Property Settlement Note Income; and more. Although all sources of income are considered “income” by the recipient, it is important to understand that from a mortgage financing perspective, not all sources of income are considered “Qualifying Income.”
In order to be considered as “Qualifying Income” certain requirements of each income source must be met. For divorcing clients who will need mortgage financing once the divorce is final, involving a mortgage professional who specializes in Divorce Mortgage Lending during the divorce process rather than post decree can potentially help avoid common pitfalls when “Income” is not considered as “Qualifying Income.” Alimony/Maintenance, whether unallocated or allocated, along with child support must meet specific requirements to be considered as “Qualifying Income” for mortgage financing purposes by meeting both continuance and stability tests.
Continuance: A key driver of successful homeowner ship is confidence that all income used in qualifying the borrower will continue to be received by the borrower for the foreseeable future. Must be able to document that income will continue to be paid for at least three years AFTER the date of the mortgage application. Check for limitations on the continuance of the payments, such as the age of the children for whom the support is being paid or the duration over which alimony is required to be paid.
Stability: A review of the payment history is required to determine its suitability as stable qualifying income. To be considered stable income, full, regular, and timely payments must have been received for six months or longer.
One of the main concerns when one party is retaining the marital home is that the vacating spouse will not be able to qualify for future mortgage financing while their name remains on the current mortgage. While many investors have their own guidelines or ‘overlays’ to Fannie/Freddie underwriting guidelines, a divorce mortgage professional will know how to handle Court-Ordered Assignment of Debt.
When a borrower has outstanding debt that was assigned to another party by court order (such as under a divorce decree or separation agreement) and the creditor does not release the borrower from liability, the borrower has a contingent liability. The lender is not required to count this contingent liability as part of the borrower’s recurring monthly debt obligations.
One of the two most common loan scenarios divorce lending professionals will handle is the refinance of the marital home – either to simply refinance one spouse off of the existing mortgage or in order to pull equity from the home awarded to the departing spouse through the divorce settlement agreement. When pulling equity from the existing home, the number one lender error in divorce lending is the lack of knowledge that an equity buy out is NOT a cash out refinance transaction. Both Fannie Mae and Freddie Mac acknowledge it is already a detriment to divorcing clients going through a divorce and there is no need to penalize them any further with a cash out hit to the interest rate.
There are a few guidelines that must be met in order for the equity buyout to be classified as a Limited Cash-Out Refinance Transaction.
Acceptable Use – buying out a co-owner pursuant to an agreement. The divorce settlement agreement must specifically state the marital home is to be refinanced in order to transfer cash value equity to the departing spouse. The property must have been jointly owned per title vesting for at least 12 months preceding the date of the mortgage application.
Cash Back to the Borrower. There can be zero cash back to the refinancing borrower who is retaining the marital home. The Divorce Settlement Agreement must state the specific amount of equity to be pulled from the marital home and all of this cash equity must transfer directly to the departing spouse. Any dollar amount taken in excess of the equity buy out will shift the transaction to a cash out refinance.