Divorce is a life-altering event that forces individuals to confront many financial decisions—one crucial decision centers around the family home and, more specifically, the mortgage. While retaining a low-interest rate mortgage post-divorce may seem attractive, it's essential to understand the actual cost involved.
Let's explore the financial implications of keeping such a mortgage, including how it may require sacrificing other marital assets or result in a potentially higher tax bill.
Low-interest rate mortgages have been a staple of the housing market in recent years, allowing homeowners to secure financing at historically favorable terms. These mortgages reduce monthly payments, making homeownership more affordable.
In many divorces, one spouse may want to keep the family home, driven by emotional attachment, stability for children, or a desire to avoid the disruption of moving. In such cases, keeping the existing low-interest rate mortgage can be enticing.
The Hidden Costs of Keeping a Low-Interest Rate Mortgage
One of the significant considerations when opting to keep a low-interest rate mortgage post-divorce is the impact on the division of marital assets. To offset the value of this desirable mortgage, the divorcing couple may need to allocate other assets, such as retirement accounts, investments, or personal savings, to achieve an equitable division.
While keeping a low-interest rate mortgage can save on monthly payments, it may have tax implications. The interest on a mortgage can be tax-deductible, potentially reducing an individual's taxable income. Divorcing spouses don't immediately realize the impact their future tax filing status may have on their overall year-end tax liability, which could result in a higher tax bill at the end of the year. Changing your tax filing status from Married Filing Jointly to Single or Head of Household may be a more significant change than expected.
Consider the following:
- Jane has a taxable employment income of $86,400.
- The original marital mortgage was $550,000 with a 30-year fixed rate mortgage rate of 3.25% and a balance of $400,000.
- To refinance the existing mortgage balance of $400,000, Jane's new interest rate would be 7.25%.
- Over the same 12-month period, Jane would pay the following in mortgage interest:
- Existing balance at 3.25%: $11,891
- New Loan at 7.25%: $28,873
- Annual Property Taxes on the marital home: $6,000
- Jane's potential adjusted gross income calculations:
- With existing marital mortgage: $68,509
- With new mortgage: $51,527
- Under the 2023 Tax Tables for Single Filers, Jane's estimated year-end tax liability would be:
- Current Mortgage Situation: $10,379
- New Mortgage Situation: $6,643
- Keeping the existing mortgage in place could result in a higher tax bill of $3,736 in the first year alone. That's equivalent to $311.33 monthly!
- If John is to get $175,000 as his share of equity, the question remains how to equalize the equity in the marital home if Jane wants to keep the existing mortgage.
- John could take the $175,000 investment account, earning 7.2% annually, as an alternative. Should Jane give up this asset, the cost of doing so could be $12,600 annually ($1,050 monthly).
Navigating the Decision-Making Process
To make an informed decision about retaining a low-interest-rate mortgage, it's crucial to assess the actual cost. This entails understanding the potential impact on the division of assets and the tax implications.
Engaging the services of a financial advisor with expertise in divorce can be invaluable. These professionals can provide insight into the tax implications, asset distribution, and long-term economic impact of keeping a low-interest rate mortgage.
Consulting with a tax professional can help divorcing individuals understand the tax consequences of their decisions, enabling them to plan effectively and potentially mitigate tax liabilities.
The allure of keeping a low-interest rate mortgage post-divorce is undeniable, offering lower monthly payments and stability. However, it's essential to recognize the actual cost involved, including potential sacrifices in the division of marital assets and tax implications that may lead to a higher tax bill. By carefully weighing these factors and seeking professional guidance, divorcing individuals can make informed decisions that align with their long-term financial well-being. Ultimately, the decision to retain a low-interest rate mortgage should be part of a broader economic strategy tailored to the unique circumstances of each divorce.
How are you integrating divorce mortgage planning into your case management?
Divorce Mortgage Planning is the ability to put into play the desired outcome by pairing the needs and options available while helping to incorporate the necessary details and clarity into an executable settlement agreement to obtain closure and peace of mind successfully.
Working directly with the divorce team, a CDLP® incorporates divorce mortgage planning into the overall process with a unique and solid understanding of the intersection of family law, financing and tax planning, real property, and mortgage planning.
Involving a Certified Divorce Lending Professional (CDLP®) early in the divorce settlement process can help the divorcing homeowners set the stage for successful mortgage financing in the future.
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.
Copyright 2023—All Rights Divorce Lending Association