Understanding Equity Buy-Outs in Divorce: Mortgage or Process?

There is a lot of confusion and misunderstanding about equity buy-outs during a divorce. Is it a mortgage or a process?

An equity buy-out is the process of acquiring the equity ownership of an existing legal owner of real property. Acquiring the equity ownership in the marital home from an ex-spouse is most commonly done by refinancing the existing mortgage.

When a divorce involves refinancing the marital home, divorcing borrowers typically aim to pull equity out of the home to buy out the other spouse’s equity ownership. Although the divorce settlement agreement may outline the details of the transfer of ownership, it does not determine the type of financing available for the divorcing borrower.

What is an Equity Buyout?

The term "equity buyout" can confuse some people into thinking they have to purchase the house from the other spouse. This isn’t true; an equity buyout is handled as a refinance loan, not a purchase loan. There are two types of refinances to consider because a court order for one party to buy out the equity of the other does not dictate the refinancing category it will fall under, and each type has its limitations and requirements.

Two Types of Refinances in Divorce

The two types of refinances are Rate/Term refinance and Cash-Out refinance. Rate/Term refinances typically offer better terms with lower interest rates and access to more equity. Conversely, a cash-out mortgage may have a higher interest rate and typically allows access to only up to 80% of the home’s value, which can present a problem when the goal is to access equity.

The divorce settlement agreement must be structured so that the divorcing borrower can refinance as a Rate/Term equity buyout. This structure allows the divorcing borrower to access the equity in the home without higher pricing adjustments or refinancing issues.

Specific Requirements for Divorcing Borrowers

To structure a refinance as a Rate/Term equity buyout, the divorcing borrower must meet specific requirements, which include:

The equity buyout must be addressed independently in the homestead or real estate section of the marital settlement agreement. It cannot be included in an addendum listing all marital assets.
No cashback is allowed to the borrower for debt consolidation, attorney fees, etc. Not one penny can be due to the borrower at closing, even if it results from overestimated fees.
The borrowing spouse must have been on the title for the previous 12 months. This is crucial if the mortgage and title were in the husband’s name and the wife was awarded the marital home and needs to refinance. Although the court order makes her a Successor of Interest, allowing her to refinance even if she isn’t on the current mortgage, the court can’t dictate the refinancing category.

Why Involve a Certified Divorce Lending Professional (CDLP®)

A divorce involving an equity buyout can be complex. Working with an experienced mortgage professional specializing in divorcing clients and understanding the different types of refinances involved in an equity buyout is crucial.

A Certified Divorce Lending Professional (CDLP®) brings tremendous value to the divorce team during the settlement process. Their knowledge of family law, financial and tax planning, real property, and mortgage financing allows them to support and assist the divorce team and divorcing homeowners effectively.

Benefits of Working with a CDLP®

Working with a Certified Divorce Lending Professional (CDLP®) and incorporating Divorce Mortgage Planning into the divorce settlement may help both spouses obtain new mortgage financing post-divorce.

Contact a CDLP® today for a copy of the Divorcing Your Mortgage Homeowner Workbook, a guide to credit, real estate, and mortgage financing after divorce. This workbook will help you get organized, be prepared, and understand your mortgage financing position, whether you need to refinance the marital home in an Equity Buy-Out situation or prepare to sell and purchase a new home post-divorce.

This is for informational purposes only and not for the purpose of providing legal or tax advice. You should contact an attorney or tax professional to obtain legal and tax advice. Interest rates and fees are estimates provided for informational purposes only and are subject to market changes. This is not a commitment to lend. Rates change daily – call for current quotations. The information contained in this newsletter has been prepared by, or purchased from, an independent third party and is distributed for consumer education purposes.