A couple going through a foreclosure at the same time they are going through a divorce should be aware of a number of issues that may arise as a result of the two simultaneous processes: Who is responsible for the remaining debt on the home? How will the debt be repaid? What will happen to the house?
A divorcing couple in foreclosure must first figure out whether the debt is the responsibility of a single spouse or both spouses. Did just one spouse sign the mortgage loan documents? Or did both spouses sign? As you know, signing a promissory note and mortgage has important legal and financial ramifications. (A promissory note is basically an IOU that contains the promise to repay the loan, as well as the terms for repayment. The mortgage provides security for the loan that is evidenced by a promissory note.)
If a foreclosure occurs, the spouse who signed the mortgage documents will suffer a drop in credit rating, but the other spouse’s credit score won’t be affected at all. If only one of the spouses signed the documents, that spouse is wholly responsible for repaying the mortgage loan. If there’s a deficiency remaining after the foreclosure sale (and state law allows lenders to sue borrowers to recover the deficiency; see our article on Deficiency Judgments After Foreclosure), the lender can only go after the spouse named in the promissory note (which is the document that created the promise to pay).
More often than not, both spouses will have co-signed the loan documents and will both be liable for the mortgage debt.
If one spouse wants to keep the house after a divorce, that spouse can assume the entire mortgage loan, even if the other spouse is the only signer on the mortgage or both spouses are co-signers on the mortgage. (This is true as long as there is no language in the mortgage that specifically forbids an assumption. See “Is There a Due-on-Sale Clause?” below.)
While most home mortgages don’t specifically forbid borrowers from assigning their rights and obligations under the mortgage to a third party, most of them do include something called a “due-on-sale clause.” This type of clause states that if the property is sold or conveyed, then the entire loan balance will be accelerated (become due). Most mortgages contain a due on sale clause.
Generally, the due-on-sale clause is the only tool lenders have to prohibit borrowers from transferring the mortgage or the property. If there is no due-on-sale clause in a mortgage, one spouse can legally transfer title to the property and the mortgage to the other spouse without the lender’s consent.
Even if there is a due-on-sale clause in the mortgage, one spouse can still assign the property and the mortgage entirely to the other spouse without the lender’s consent because of a law called the 1982 Garn-St. Germain Act. Under this federal law, lenders may not enforce an otherwise valid due-on-sale clause if a mortgage or property is transferred as a result of a divorce decree, legal separation agreement, or a property settlement agreement. 12 U.S.C. § 1701j-3(d). The lender can’t require any new underwriting, nor can it prohibit the mortgage transfer just because the mortgage is in default.
The spouse that wants to keep the house and assume the mortgage after the divorce should contact the lender’s assumption department rather than the loss mitigation department. The lender may ask for a copy of the divorce decree or a quitclaim deed from one spouse to the other.
Once the parties to a divorce decide what to do with the house and mortgage—whether one spouse wants to become the sole owner or neither spouse wants to take ownership—there are a number of options available to avoid foreclosure. If neither spouse wants the house any longer, they can attempt a short sale or deed in lieu of foreclosure.
If one spouse will take over the property and the mortgage, that spouse can then apply on his or her own for a modification or refinance, either under the federal government’s Making Home Affordable program or directly with their lender.
For more information, see this page on Avoiding Foreclosure During Divorce.