How Do We Divide the House in Divorce?

One of the most troublesome problems facing divorcing couples in a “down” real estate market involves division of the marital residence (or other real property they may own together). Often, couples have little or no equity in the marital residence and neither spouse will be able to re-finance the debt into their name alone.

When both spouses are joint debtors under the mortgage, a divorce decree by itself will not limit their individual liability for payment of that mortgage, and in these economic times, many mortgage lenders will not agree to release one spouse from individual liability under the mortgage.

Traditionally, one spouse agrees to be responsible for the mortgage payments (becoming essentially the property “owner”) and to indemnify the other spouse from any claims by their mortgage company until the house is sold or the mortgage is paid off; this agreement is usually secured by a lien against the marital residence (so that the other spouse is now placed in the role of a “lienholder” although behind the mortgage lender and perhaps other creditors). In other words, the “lienholder” spouse giving up the marital residence has to hope that the “owner” spouse will be able to continue making mortgage payments after the divorce and – if he or she can’t – must be ready to step in and pay the mortgage to avoid foreclosure of the property and being sued individually for any deficiency between the sales price and the accelerated amount of the mortgage.

If the marital residence has “equity” – in other words, if the value of the property is substantially more than the full amount required to pay off the mortgage – this is generally not a problem. But if the marital residence has little to no equity, or is “underwater” because the property is now worth less than the amount of the mortgage, divorcing spouses have to make some very tough decisions concerning future liability and financial risk.

Even when a divorce is “agreed” and there are essentially no disputes between the spouses about dividing marital assets, in situations where the marital residence or other real property carries substantial debt and little equity, it is best to consult with a family/divorce lawyer to advise you on potential methods for handling the marital residence in a way that will help limit exposure to potentially large and unexpected expenses after the divorce has become final.

Blog by Cynthia W. Veidt

Real Property Division in Divorce

One of the more difficult assets to divide during a divorce is that of real property, such as the marital homestead. The reasons for the difficulties include: (1) the fact that both of the parties reside in the home, (2) it can accumulate a substantial amount of equity, and (3) there is usually secured debt upon the residence (mortgage, home improvement loans, or home equity financing). As a result, most personal property, stocks, bonds, and financial accounts are easier to split up. There are potentially many ways to deal with real estate. However, in the situation where the divorcing spouses jointly own a single, marital residence, descriptions of the two most common ways to deal with the house:

(1) Sell The Home: The home can be listed for sale with a real estate broker and sold. The net proceeds of the sale (if any) would then be divided between the spouses as any other asset of the marriage. This is certainly the simplest way to go. It promotes certainty, it is easy to figure the equity, and it removes a significant liability and the entanglements that come with joint ownership and the joint liability. However, it will displace the family, including the children from the home. As a result, it will likely be the most disruptive. The other downside with selling the home is that there are usually significant closing costs with the sale and disposition of real estate. These expenses will be duplicated three times if each of the spouses are going to then buy their own home after the divorce.

(2) Conveyance to the Other Spouse: The second most common option regarding the marital homestead is a conveyance from one spouse to the other. Usually when children are involved the "primary" parent is the one that stays in the house. For example, in one of the the most common scenarios, the Wife stays in the home with the children and the Husband moves to an apartment. In this example, the Husband would sign a Deed (what is generally referred to as a Special Warranty Deed) and the Wife would then own the home outright. Most people understand that one spouse then owns the home, but many people do not understand what happens with the secured debt on the home.

WHAT ABOUT THE SECURED DEBT? Occasionally, the Judge will Order that the spouse who received the home refinance it (or the parties will agree to this), but oftentimes (due to high-interest rates, lack of credit, lack of income to justify the mortgage ratios, or, as we have now, the possibility of a lack of available lenders and funding) the acquiring spouse will not be able (or it will not be economically feasible) to refinance the home. What many people don't realize in this situation is that just because the home is conveyed from one spouse to the other, does not mean that the conveying spouse is no longer liable for the debt. The spouses and the Court cannot modify the contractual rights of the Mortgage Lender. Additionally, unless there is substantial equity in the home, and, in part, due to the fact that during a divorce the lender will be concerned regarding repayment, it is very rare that the lender would be willing to release the conveying party.

In this situation, the family law lawyer can assist by preparing the documents necessary to equalize the rights of the parties. In essense, the acquiring spouse will "asssume" the mortgage indebtedness. The conveying spouse will then receive a Deed of Trust to Secure Assumption (DOTTSA) - signed by the acquiring spouse. The Deed of Trust to Secure Assumption will allow the conveying spouse to foreclose his or her own lien, reacquire the property, and then either refinance, cure, or pay-off the note(s) owned by the Lenders (and potentially any other liens that have been placed upon the property).

A "Second lien" is what is held by the conveying spouse. This type of lien is generally "inferior" to that of the "superior" Purchase Money Security Interest that will be held by the Mortgage Lender. Because of the fact that the lien held by the conveying spouse is inferior, it is important for this spouse to notify the Mortgage Lender of this lien (preferably in writing) so that in the event of a foreclosure, the lender will notify the inferior lien holder of the impending foreclosure. This will allow the spouse holding the inferior lien to cure any defaults and then foreclose him or herself. The foreclosure will be "subject to" the lien held by the Mortgage Lender. In other words, the primary note will still have to be refinanced, paid-off, or sold with the new buyer then "assuming" the Note and making the payments. Because of the relative speed at which a Mortgage Lender can foreclose (potentially 45 days with a residence, and even less on non-residential property), it is important to keep up with the status of the loan.

WHAT ABOUT THE EQUITY? Because the spouses can build up a substantial amount of equity through: (1) payments on the mortgage, (2) an appreciation in value of the home, and/or (3) home improvements (sometime referred to as "sweat equity," many times the spouses are confronted with the difficult task of attempting to fairly dividing the marital assets when the marital residence has substantial value. This is generally accomplished inat least three ways.

(1) Refinance the Home and Pay Cash. The first way, as discussed above, is to do a refinance of the home and take the "cash out" option. If this can be done it is the easiest way, but, as addressed above, sometimes the acquiring spouse will not be able to make use of this option.

(2) Offsetting Assets. The next way to do this is with offsetting assets. For example, if there is a retirement account or another assets with substantial value the other spouse can receive this asset, rather than equity out of the home.

(3) Owelty Note. An "Owelty" Note -- think of it as "I Owe" -- is one of the ways to accomplish the equalization. In this option, the conveying spouse would, in essence, become a secured lending for his / her spouse. The Note can carry with it any number of terms as with any other Note, such as interest only payments, a balloon, equal month payments, or other financial options. You will want to discuss these potential options with your attorney to come up with a plan that works for everyone. Again, this type of Note would be a second lien and have the peculiar problems associated with this type of Note. This option also requires more involvement by the family law lawyer, but it is a relatively easy way to equalize the equity.

FAQ regarding Divorce # 16: Is there a way for me to continue living in the house with the children?

This question commonly arises for the simple fact that parents often believe that it is best for their children to have continuity by living in the same house. The equity in your home is like any other asset that is subject to division by the Divorce Court. The home can be sold and reduced to cash, but oftentimes this is not necessary. Sometimes, another asset can go to the other spouse, including retirement accounts of either spouse, to offset the large amount of equity received by the spouse who keeps the house.

Also, like any other commercial transaction, one spouse can essentially “loan” money to the other by taking back a Note and Deed of Trust (usually “junior,” or of a lesser stature, to the financing or mortgage used to purchase the house). This relationship is sometime referred to as an Owelty Deed or Owelty Lien, or sometimes as a Second Deed of Trust. This is nothing more than one spouse promising to pay the equity in the home over time (with a Promissory Note or simply a Note) and the other spouse receiving a Deed of Trust or other form of security so that if the Note is not paid, that party has recourse to ensure payment (which may include the ability to foreclose upon the house).