The skyrocketing foreclosure rate is hitting divorcing couples hard. For the average divorcing couple the expense of maintaining two households, where there had been only one, is a financial challenge even in good times. Throw in a job loss, ballooning mortgage payments and overextended credit obligations, and the odds of facing a mortgage default goes through the roof.
Because of expensive mortgages and falling home values, many homeowners now have negative equity in their homes, meaning that the value of the homes have fallen below the mortgage balances. Consumers with negative-equity mortgages are sometimes referred to as being underwater or upside down. This becomes problematic if the homeowners have to sell in a divorce; if such a home is sold at market rate, the proceeds would no longer be enough to pay off the mortgage. Even if all proceeds were applied to the mortgage, the mortgagor would still be liable for the balance of the loan.
One viable alternative to foreclosure for a divorcing couple, that needs to sell the family home, may be the short sale. In a short sale, the bank agrees to allow the home to be sold at market rate and accept the proceeds in satisfaction of the mortgage, even though it is less than what is owed. The difference between the sales price and the mortgage liability is essentially forgiven debt.
This can be a win-win for both the lender and the homeowners: the bank does not have to go through an expensive foreclosure or assume ownership, and sometimes assume the responsibility for upkeep and resale of the home, and the divorcing couple can walk away free of the house and the mortgage liability, and without the more serious blow to their credit a foreclosure can deliver. Although, there may be negative credit implications that stem from a short sale that a homeowner should be aware of.
Of course, the particular lender must be open to a short sale. The logistics, however, can be difficult during divorce. Short-sale negotiations are notoriously arduous and can take months when the divorcing spouses would just as soon be on with their new lives. Sometimes the lender ultimately will not agree to accept less than the mortgage if it feels the borrowers could pay the difference from other resources.
The part of the mortgage debt forgiven in a short sale has traditionally been viewed by the government as taxable income. However, in most situations, the Mortgage Debt Relief Act of 2007 forgives this debt-forgiveness tax on the federal level for mortgage restructuring or discharge on a principal residence through 2012. However, a divorcing couple will have to negotiate responsibility for any state debt-cancellation taxes.
Facing possible foreclosure on the marital home during divorce can raise challenging logistical and legal questions:
- Does it make sense for one spouse to try to keep the home?
- If the lender will refinance or renegotiate terms to lower the monthly mortgage payment, will it approve the revised mortgage considering the income of only one spouse, or will both be required to sign, leaving the couple tied legally even beyond the divorce?
- Should the couple negotiate in their divorce settlement agreement who will be liable for any future taxes if the marital home is sold in a short sale after the divorce?
- Might bankruptcy be a better alternative than a short sale or foreclosure?
Anyone trying to negotiate a divorce complicated by a possible mortgage default should get competent professional advice. The guidance of an experienced, skilled family law attorney, and of tax and financial planners can be invaluable. Every potential foreclosure in a divorce is a unique intersection of applicable state and federal law, the terms of the mortgage contract, the position of the lender and the characteristics of the divorcing spouses.