Divorce brings significant emotional and financial challenges, particularly when it comes to managing shared assets like a home. If you and your spouse share a mortgage, navigating the division of this responsibility is a crucial step in moving forward. While divorce agreements or court orders may allocate property ownership and financial responsibility, these directives do not automatically release either party from joint liability under the mortgage contract. Lenders require specific actions to remove one party, making it essential to understand your options and obligations.
Let me outline the primary methods for handling a shared mortgage during divorce, including refinancing, selling the property, assuming the mortgage, or utilizing spousal buyout programs. Each option comes with unique financial implications, qualifications, and potential penalties, and choosing the right path depends on your circumstances. Whether you’re aiming to retain the family home or achieve a clean financial break, understanding these strategies can help you make informed decisions and minimize potential pitfalls.
Understanding Joint Responsibility
Suggestions for Managing Mortgage Penalties
Understanding Joint Responsibility
If both spouses are on the mortgage, both are legally responsible for the debt, even after separation. Divorce agreements (or court orders) may allocate responsibility, but lenders are not bound by these. Both parties remain accountable unless one is removed from the mortgage.
Everyone’s situation is different. Usually when a couple purchases a home, they purchase it as joint tenants. Under joint tenancy, both partners have an equal share in the property. It is possible for them to purchase the home as tenants in common where each co-owner holds an individual and distinct share of the property, which can be equal or unequal. Under joint tenancy and tenants in common, both partners are on title, but their ownership interest could be different.
It is possible for both spouses to be on the mortgage, or only one of the spouses could be on the mortgage. If only one of the spouses is on the mortgage, even after separation or divorce, they are solely responsible for the mortgage.
Available Options
Generally, when divorcing, one of the following options is chosen to handle the couple’s mortgage obligation during divorce:
- Refinancing the Mortgage
- Selling the Property
- Assuming the Mortgage
- Spousal Buyout Program
Refinancing the Mortgage
One spouse can refinance the mortgage in their name to remove the other spouse. The refinancing spouse (spouse who is keeping the home) must qualify on their own based on their:
- Income.
- Credit score.
- Debt-to-income ratios (GDS/TDS).
To refinance the mortgage, the refinancing spouse:
- Applies for refinancing with a lender through their mortgage agent.
- Provides proof of income, assets, credit score, and separation agreement.
- Pays any penalties or fees for breaking the existing mortgage (as applicable, which could be substantial). Generally, the fees are the responsibility of each partner on the mortgage and their payment should be negotiated. See breaking your mortgage.
- There will be other costs such as legal fees and appraisal costs that also need to be considered and negotiated.
The refinancing spouse must have sufficient income, equity, and credit to qualify alone. Appraisal fees, penalties, and legal costs may add to the financial burden.
Selling the Property
If neither spouse can afford the mortgage alone, selling the property may be the best option.
In selling the property, the spouses:
- Agree on the sale terms (outlined in a divorce agreement).
- Pay off the mortgage using sale proceeds.
- Split any remaining equity or address any shortfall based on the divorce terms.
By selling the property, the former couple clears their joint debt entirely. This avoids the need for one spouse to qualify for refinancing.
It should be noted that there is a good chance there will be mortgage penalties applicable depending on the terms of the mortgage contract. If a fixed rate mortgage is in place, the couple will likely face the highest penalties as they are usually calculated based on the interest rate differential. If a variable rate mortgage is in place, penalties tend to be limited to three months interest on the remaining balance.
Penalties can be avoided if either spouse is planning to buy a new property and want to port the mortgage (transfer it to a new property) to avoid penalties. Contact Allen Ehlert for details.
Further, the divorcing couple can wait until the mortgage term expires, which also mean there are no penalties, but this may not be practical in divorce situations where the property needs to be liquidated promptly. Under some circumstances (rare), some lenders waive penalties under the terms of a spousal buyout.
Alternatively, the emotional attachment to the home may complicate the decision, and market conditions could impact the sale price.
Assuming the Mortgage
Some lenders allow a spouse to assume the existing mortgage instead of refinancing, avoiding penalties for breaking the mortgage.
To be able to assume the mortgage, the assuming spouse must qualify for the mortgage under the lender’s criteria (not all mortgage products have an assumption option) and the lender must agree to release the other spouse from liability. A lender may allow one spouse to be release from liability if the spouse who remains on title and on mortgage has the capacity to manage and meet the mortgage requirements.
By assuming a mortgage you may avoid breaking the mortgage and being on the hook to pay substantial mortgage penalties. The problem is not all lenders or mortgage products permit assumptions and frequently the remaining spouse doesn’t qualify for the mortgage on their own.
The larger problem, depending on the size of the mortgage, is the ability of a spouse to qualify for the mortgage they want to assume on their own.
Spousal Buyout Program
In Canada, a spousal buyout mortgage allows one spouse to refinance up to 95% of the home’s appraised value to buy out the other spouse’s equity. This program is designed specifically for divorce situations. A spousal buyout is a way to refinance your home so one spouse can continue living in the home while the other souse is paid out.
It essentially creates a new mortgage that pays out your existing mortgage and debts enabling your lawyer to divide anything remaining between the ex-partners. One ex-spouse is removed from title, and the other ex-spouse keeps the home.
For example, let’s say Bob and Lisa want to divorce. They own a $900,000 home and have $400,000 remaining on their mortgage, and another $20,000 of debt. Bob and Lisa have negotiated through their separation agreement that says they will also split the non-mortgage debt.
This leaves $480,000 in equity to divide.
The new mortgage would roughly be:
$500,000 (remaining mortgage) + $10,000 (50% of debt) +$250,000 (spousal buyout) =$760,000
$760,000 of $900,000 (value of home after appraisal) is about 84% loan to value (most lenders will go as high as 95%.
What’s missing from this example are the penalties that must be paid for breaking the original mortgage. Depending on the type of mortgage (open, closed, fixed, variable), different penalties and penalty calculations apply. For example, if the clients had a 5-year fixed mortgage (most common) and they were halfway through their term, they could be looking at a penalty to break their original mortgage that would cost them tens of thousands of dollars. As both partners are on title and on mortgage, it is their joint responsibility to pay the penalty to break their mortgage.
Suggestions for Managing Mortgage Penalties
Assuming you don’t have an open mortgage (no mortgage penalties apply to open mortgages), the following may be possible depending on your situation:
- Portability Within the Same Lender
- Lender’s Discretion
- Blended Rate Option
- Mortgage Assumption
Portability Within the Same Lender
Some lenders may allow a seamless transition within the same mortgage product, avoiding penalties if the mortgage balance is the same or increased to accommodate the buyout and the term and interest rate remain unchanged. The reason for not charging you a mortgage penalty in this instance is that you are not deviating materially from the standard charge terms of the original mortgage; you are merely continuing with the present mortgage albeit with a nonmaterial adjustment. This portability is lender and mortgage product dependent.
Lender’s Discretion
Certain lenders may waive penalties during a spousal buyout if the buyout and refinancing are part of a court-ordered separation or divorce agreement and the lender wants to retain the mortgage business and views this as a customer retention strategy. Such an accommodation is an exception and the customer must have considerable business with the lender to forgo the substantial mortgage penalties available to the lender.
Blended Rate Option
Instead of breaking the mortgage, some lenders allow the remaining spouse to “blend and extend” the existing mortgage. This involves combining the current rate with the new market rate, avoiding penalties but potentially resulting in a slightly higher interest rate. Like the portability option above, the reason for not charging you a mortgage penalty in this instance is that you are not deviating materially from the standard charge terms of the original mortgage; you are merely continuing with the present mortgage albeit with a nonmaterial adjustment from the perspective of the lender’s policies and the attributes of the original mortgage product. This ability to blend and extend is the lender and mortgage product dependent.
Mortgage Assumption
Some lenders allow a spouse to assume the existing mortgage instead of refinancing, avoiding penalties for breaking the mortgage.
To assume a mortgage, the mortgage product and the lender’s policies as per the charge terms of the mortgage must allow mortgage assumption. Many low-rate mortgages do not provide for this option. For the remaining spouse to be able to assume the existing mortgage, they must have a strong enough profile to be able to support the mortgage on their own in terms of debt service ratios, income, credit score, and equity.
Summary
Divorce can be a complex and emotional process, particularly when it involves shared financial commitments like a mortgage. Understanding the available options and their implications is key to making informed decisions that align with your financial and personal goals. Whether refinancing, selling the property, assuming the mortgage, or utilizing a spousal buyout program, each path offers distinct advantages and challenges.
Key considerations include understanding joint liability, addressing potential penalties, and evaluating personal financial capabilities. Solutions like spousal buyouts and blended rate options provide specialized avenues to manage financial separation while minimizing costs and disruptions. However, these options often depend on lender policies, individual qualifications, and the terms of the mortgage contract.
Ultimately, clear communication, thorough financial planning, and professional guidance—whether from mortgage agents, legal experts, or financial advisors—can help divorcing couples navigate these decisions effectively. By taking proactive steps and exploring all available strategies, individuals can mitigate financial stress and move forward with greater stability during a challenging time.
