Divorce can be intricate, tricky, and emotionally overwhelming. When you have to relocate, find new housing, and decide whether to rent or purchase a new home, the tasks can be frustrating. Many divorcing spouses consider buying a new home with cash, but they may not realize the risks involved.
Benefits of Owning a Home vs. Renting After Divorce
Many divorcing spouses understand the financial benefits of owning a home rather than renting. While obtaining mortgage financing involves a lot of paperwork and challenges, doing so during a divorce may seem overwhelming and out of reach for many.
Risks of Buying a New Home with Cash After Divorce
For various reasons, divorcing clients may decide that buying a new home with cash is the right move. However, new home buyers who are in a position to pay cash need to ensure it is the right financial decision and protect their ability to use the mortgage interest deduction on future mortgages.
Two Categories of Mortgage Interest Deduction
The mortgage interest deduction is divided into two categories: Acquisition Indebtedness and Home Equity Indebtedness. Acquisition Indebtedness is any mortgage obtained to purchase (acquire) or significantly improve the home. Home Equity Indebtedness is any mortgage obtained for reasons other than acquisition.
Why Use Cash to Buy a Home?
When a new homeowner buys their home with cash, they need to consider their intent:
- To avoid mortgage financing?
- Unable to obtain mortgage financing due to an ongoing divorce?
- Unable to meet the requirements to use maintenance or child support as qualified income?
- High debt-to-income ratio due to spousal support obligations?
- To make their purchase offer more attractive in a hot seller's market?
Whatever the reason, consulting a financial adviser is crucial to avoid losing future mortgage interest deductions for tax purposes. If the intent is to take out a future mortgage to replenish cash reserves used to purchase the home, there is a time limit to do so. Otherwise, they risk losing future mortgage interest deductions on the new loan.
IRS Tax Guidelines on Mortgage Interest Deduction
Currently, IRS Tax Guidelines have a 90-day window for new homeowners to apply for a new mortgage after buying a home with cash. This ensures the new mortgage is classified as Acquisition Indebtedness. If a new mortgage is not applied for within this initial 90-day window, any new mortgage will be categorized as Home Equity Indebtedness, which has a mortgage limit of $100,000 and is non-tax-deductible through 2025.
Get Expert Help from a Certified Divorce Lending Professional (CDLP®)
Involving a Certified Divorce Lending Professional (CDLP®) early in the divorce settlement agreement can help divorcing homeowners set the stage for successful mortgage financing in the future.
Role of a CDLP® in Divorce Mortgage Planning
Divorce Mortgage Planning involves evaluating your mortgage options within the context of your overall financial objectives during your divorce. Working directly with your divorce team, a CDLP® understands the intersection of divorce, tax, real estate, and mortgage financing. The CDLP® helps you integrate the mortgage you select into your long and short-term financial and investment goals, minimize taxes, reduce interest expenses, and maximize cash flow.
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.
Copyright 2021—All Rights Divorce Lending Association.
