Divorce & an Underwater Mortgage That a Spouse Refuses to Sell

by Beverly Bird
Marital debt isn't relieved by a divorce.

Marital debt isn't relieved by a divorce.

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Divorcing in tough economic times can be a real challenge. Often, a couple’s most valuable asset is their home. When the home is underwater -- worth less than the mortgage against it -- it becomes a debt, not an asset. Courts apportion marital debts between spouses in a divorce as well, so when one spouse keeps the home, equitable divorce distribution becomes a complex issue.

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When a mortgage is in both spouses’ names, the primary challenge when one spouse keeps the home is to relieve the other of any legal responsibility for making the mortgage payments. The spouse keeping the home usually accomplishes this by refinancing the existing mortgage. When the home is not worth as much as the mortgage, refinancing is usually difficult. However, the federal government has programs in place to help in these situations, such as the Home Affordable Refinance Program. Some lenders will agree to refinance an underwater mortgage. However, this requires that the spouse who wants to keep the home have an income sufficient to make the mortgage payments on his own. It also requires the spouse who is not keeping the home to assume other marital debt in an amount equal to the underwater portion for which the other spouse is assuming liability. She should also receive another asset equal in value to half the home’s appraised worth.

Paying off the Mortgage

Another option is to use other marital assets to pay off the mortgage, or at least the underwater portion. This makes it easier to achieve equitable distribution of assets and debts between spouses. However, if one spouse refinances the mortgage and assumes responsibility for the underwater portion, and if the court assigns an equal amount of debt to the spouse not keeping the home, that spouse could potentially come out shortchanged. This is especially true if she does not receive another asset equal to half the home's appraised value at the time of the divorce. If the spouse who refuses to sell holds onto the home long enough, it might appreciate when the economy improves. In this case, he would receive all that equity at a later date without having to share any of it with his spouse. To avoid this, courts will sometimes order liquidation of other assets to either pay off the mortgage or to pay off the underwater portion. The joint assets eliminate the joint debt at the time of the divorce, making everything even going forward.

Making the Payoff Work

If there are no marital assets left after liquidating them to pay the mortgage, the spouse who is not keeping the home should still receive compensation for her share of the equity in the home. In this case, the spouse keeping the home might have to take an equity loan to pay the other spouse a cash settlement for her half of the home's value. When the home is free and clear of liens, its value becomes a marital asset, and the other spouse is entitled to her portion of that.

When Nothing Else Works

When spouses can’t pay off the mortgage through marital assets, and if the spouse wanting to keep the home cannot refinance, courts will sometimes order spouses to relinquish the asset. This might be through a short sale, where the lender agrees to close out the mortgage for less than its value, or a deed in lieu of foreclosure, where the lender takes the deed to the house back rather than institute foreclosure proceedings. This results in a severe blemish on both spouses’ credit records. However, the court’s decision would overrule one spouse’s refusal to sell.