Often in the course of a divorce, couples find it difficult to agree on what to do with their home. In the past, when divorcing homeowners faced a foreclosure, they could simply sell the property and equitably distribute the profits. However, due to the fact that some houses are now “underwater” (where the fair market value is lower than the total amount owed on the mortgage debt), it can be difficult to sell the home at a profit or even break even on a sale. This does not mean that there are no options available when facing a foreclosure in the middle of a divorce. It is in fact possible for one spouse to retain the property, if he or she desires it, or to dispose of the property without having to succumb to foreclosure.
These foreclosure alternatives require the cooperation of both spouses, which may be difficult during a divorce.
If the property is underwater and the divorcing homeowners wish to dispose of the property, an alternative to a foreclosure is a short sale. A short sale is a transaction where the homeowners sell the property for less than is owed on the mortgage. The lender must agree to accept the proceeds, which fall short of paying off the total mortgage debt. In some cases, the difference between the sales price and the mortgage debt will be forgiven. In others, the lender may require that the borrowers remain jointly liable for the deficiency (meaning the difference between the sales price and the total debt), though it may be possible to bargain for a reduced deficiency or to offer a lump sum settlement to satisfy the remaining debt. (Or, in some cases, such as in California, state law may prohibit a deficiency judgment after a short sale.)
See Risks of Short Sales for more on the benefits and potential problems.
A deed in lieu of foreclosure (deed in lieu) is a transaction where the homeowners grant title to the property to the lender in exchange for the lender releasing them from the mortgage. This can be a viable option in a divorce to dispose of the property and avoid a foreclosure. In most cases, a deed in lieu will be in exchange for full satisfaction of the debt. However, it is possible that a deficiency could exist with a deed in lieu. If the deed in lieu documents clearly state the amount of the deficiency, which will be the difference between the fair market value and the mortgage debt, this means that the borrowers remain jointly liable for the deficiency amount. To avoid a deficiency with a deed in lieu, the borrowers must negotiate forgiveness of any deficiency amount that is owed to the lender. As with short sales, it is also possible to negotiate a reduced deficiency or pay a lump sum to settle any remaining debt associated with a deed in lieu.
See Basics of a Deed in Lieu for more detail.
When divorcing borrowers find they cannot sell the property or complete a deed in lieu, sometimes it is possible to rent the property and then apply the rental income towards the mortgage. This can, however, be a difficult option since the divorcing couple remains responsible for the property, as well as the mortgage, and must come up with a mutually agreeable arrangement for managing the rental.
If one spouse wants to keep the property, that spouse can refinance the property so that the co-borrower is released from the debt. Frequently, the terms of a divorce will require a refinance if one borrower wants to retain the property. However, refinancing may not be possible if the borrower who wants to keep the home is in financial distress due to a lost job or reduced income, or if the property is severely underwater.
Another option if one of the divorcing borrowers wants to retain the property is to apply for a loan modification, though both borrowers will remain responsible for the loan even after its modified. If one spouse won’t agree, this can be a complicated, if not unworkable endeavor, since both borrowers will need to sign the loan modification agreement. However, once a divorce settlement is finalized and one borrower is awarded the property, then that borrower can apply for loss mitigation assistance solely. If that borrower qualifies for a loan modification, the co-borrower may be released from liability on the loan and his or her signature will not be needed. Of course, this is subject to any provisions in the divorce decree. For example, if the divorce decree states the remaining borrower must refinance to remove the co-borrower from the mortgage, then a loan modification will not be granted.
The logistics of arranging any of these options can be problematic during a divorce when parties find it difficult to work with one another. If you are dealing with foreclosure during a divorce and are having a difficult time reaching an agreement with your spouse about what to do with the home, you should seek the assistance of a qualified attorney who can inform you about which options are available and can facilitate arrangements to divest or retain the property.