Cash-Out Refinance Explanation for a Divorce

by Beverly Bird

When you’re in the middle of a divorce, it’s human nature to try to avoid additional, traumatic change. This often makes possession of the marital home one of the most hotly contested issues when spouses part ways. They must either sell it or figure out how one spouse can take over the investment on their own. Cash-out refinancing offers a way to do this in some circumstances.

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What is Cash-Out Refinancing?

Cash-out refinancing occurs when you replace your initial mortgage with a new one in excess of the first mortgage's principal balance. For example, if you owe $100,000 on your first mortgage and take a new mortgage in the amount of $150,000, the new lender pays off your existing $100,000 mortgage and writes you a check for $50,000. If you own your home as your separate -- not marital -- property and your spouse has no legal interest in it upon divorce, you can use the proceeds to pay your legal costs or other associated expenses. However, even if you believe your spouse does not have any right to a portion of your home’s value, speak with an attorney to be absolutely sure. The legal definition of separate property can be tricky and is influenced by a number of factors.

Effect on Dividing the Marital Home

A couple’s home is usually a marital asset, purchased during the marriage and subject to division in a divorce. Both spouses have a right to a share of the equity -- the difference between what the home is worth and what you still owe on the mortgage. If one of you wants to retain the home, you can use a cash-out refinance to pay your spouse their share of the equity. You or your attorney must have the property appraised to set its fair market value. If the value comes in at $200,000 and your existing mortgage is $100,000, this gives you $100,000 in equity. Assuming you divide the equity 50/50 when you divorce, you would refinance for $150,000. You'd use $100,000 to pay off your existing mortgage and buy out your spouse's interest with the other $50,000.

Limitations

Sometimes, a cash-out refinance isn't a viable option. For example, if your property appraises at $125,000 and your existing mortgage is $100,000, you’d have to refinance for $112,500 to buy out your spouse’s interest. This represents a 90-percent loan-to-value ratio: the loan equals 90 percent of the home’s appraised value. Many lenders are reluctant to do cash-out refinances under such circumstances. Even if you find one who is willing, you’d probably have to pay private mortgage insurance which protects the lender if you don’t make the mortgage payments. If the lender has to foreclose, the lender may not be able to resell the home at a price sufficient to cover the loan proceeds advanced to you.

Considerations

A cash-out refinance often increases your mortgage payment because you’re borrowing more money. For example, where you were once paying down a mortgage of $100,000, you're now paying down a larger balance in order to give your spouse their equity share. However, if you can get a lower interest rate, this might even things out and the difference in payments may not be as great. Before you choose this option, know what the new payment will be and look at your budget to be sure you can afford it on your income alone.