5 Ways to Protect Equity in a Divorce Settlement

If you’re a homeowner and your marriage is ending, at some point, you’ll need to divide up equity in a divorce settlement. Assuming your home has equity, there are several steps you’ll need to take to decide who gets how much of the equity, how each person will receive their fair share and what to do with the money after the dust settles.

#1. Determine how much equity you have before your divorce

Before you decide how to handle equity in a divorce settlement, you’ll need to figure out how much home equity you have. Home equity is the difference between your home’s value and any outstanding loans or liens. Below are the two  most common ways to calculate home equity:

1. Ask a real estate agent to prepare a comparative market analysis (CMA). A CMA report compares your home to nearby sales of similar homes. The report is typically prepared by a real estate agent.
2. Get a home appraisal. A home appraisal is a more detailed report prepared by an unbiased, licensed home appraiser. An appraisal usually costs between $300 and $400, and most lenders require them for mortgage financing.

#2. Decide who gets the house in the divorce

If you don’t plan to sell the home, you’ll need to negotiate who will keep it. There are some important financial questions to answer before you decide which spouse gets the home.

Can you afford the monthly payment? It can be a shock to suddenly take on a house payment on your own if you were a two-income household. If the house will just be in your name after your divorce refinance,  you’ll need to qualify for a new mortgage based on your income and any debt you have after the divorce is completed.

Do you want the responsibility of maintenance and repairs? Many experts suggest budgeting 1% of the home’s value yearly for the upkeep of your home. You might consider buying a home warranty for extra insurance against major issues. The extra $300 to $600 average cost may be worth it if something breaks down after you become the sole owner.

How much equity will be left after the divorce? If you’re awarded the home in a divorce, you may have to “buy out” your spouse’s portion of the equity. If you don’t have the cash to cover the buyout, you may consider tapping extra equity above the balance of your current mortgage, commonly known as a cash-out refinance. However, you’ll make less profit from the home in the future if you decide to sell it.

Will you still be responsible for the mortgage after the divorce is complete? Just because the court assigns debt payments to a spouse, doesn’t mean the spouse will pay them. And if they miss payments, the lender will still ding your credit if your name remains on the mortgage. If you decide to make payments to protect your credit, you can ask the court to have your ex-spouse reimburse you.

#3. Decide how you’ll split the equity in the divorce

Although divorce attorneys typically decide how to split the equity in a divorce as part of your final divorce decree, where you live and how you currently own the home may come into play.

• Community property states.  There are currently nine community property states in the U.S. — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. In general, you’ll divide your home equity evenly if you own a home in a community property state.
• Equitable distribution states. Property owned in equitable distribution or “common law” states is based on who owns what. If you can prove you paid for or received property as a gift in a common-law state, it’s usually awarded to you.
• Title vesting. There are several different ways to take ownership of a home, also known as “vesting.”  Each title vesting option gives you different rights to use the property, and in some cases, may restrict how much “interest” you have. For example, tenancy-in-common is a type of vesting that allows you to divide the interest unequally.
• Let the judge decide in court. If you can’t agree how to split up the equity based on the options above, a judge may ultimately decide. This is especially true in common law states and may mean the home equity isn’t split 50-50.

#4.  Determine if you qualify for a refinance divorce buyout

If you want to keep the home, you may need to qualify for a refinance divorce buyout, which is a cash-out refinance to tap as much equity as you can to pay your spouse’s home equity share. You may need to brush up on minimum mortgage requirements for different programs, especially if you and your spouse qualified for the mortgage together when you bought your home.

Maximum loan-to-value ratio. Your loan-to-value (LTV) ratio is a measure of how much you can borrow compared to your home’s value. Most refinance divorce buyout mortgages allow you to tap up to 80% of your home’s value. However, if you’re a military borrower, you may be able to boost your loan up to 90% of your home’s appraised value with a loan backed by the U.S. Department of Veterans Affairs (VA).

Maximum debt-to-income ratio. Lenders look at your total debt, including the new mortgage payment to determine your debt-to-income (DTI) ratio. The Consumer Financial Protection Bureau recommends a maximum DTI ratio of 43%.  If it’s higher, you may run into trouble qualifying unless you have high credit scores or have extra cash reserves.

Credit score minimum. A conventional loan requires a score of at least 620. You may need a loan backed by the Federal Housing Administration (FHA) if your score is between 500 and 619.

#5. Decide how to use the equity if you’re selling the house after your divorce agreement is final

If you’re unable to refinance after your divorce, you may have to sell your home to protect your equity from a potential foreclosure. Depending on how much you net, you’ll have some decisions to make.

Will you buy or rent a home? If your credit was damaged because of unpaid debt your ex-spouse was responsible for, you may have to rent for a while while you repair your credit. You may also need the extra money for a rent deposit if the landlord considers your credit too risky.

Do you plan to stay in the same state or city? If you plan to move, don’t forget to budget for moving expenses. Also, check out property taxes if you’re buying in a new state —  they may be significantly higher or lower than you’re used to.

Is there any tax consequence if you don’t use the money to buy another home? As long as you lived in your house for two years before the sale and received $250,000 or less, the income shouldn’t be taxable. However, if you buy out your spouse, stay in the house and sell the home later, you may end up paying capital gains taxes. Check with a tax professional before your divorce decree is finalized to avoid tax surprises down the road.

Can you pay down debt to boost your score for a future home purchase? If you were assigned debt after a divorce, it may be best to pay it down as quickly as possible to boost your credit score. You’ll typically benefit from keeping your credit card balances at or below 30% of your total available credit.