Avoiding Foreclosure During Divorce

When a married couple takes out a mortgage to buy a home, they often obtain the loan and take title to the property jointly. If the couple then divorces, the issue of what will happen to the home can get complicated and, as a result, they might also face a foreclosure.

If you're going through a divorce, there are options that will allow you to dispose of your home, as well as alternatives if one spouse wants to remain in the home. Figuring out what you want to do with the property early on in the separation can ultimately help you avoid foreclosure.

Options If Neither Spouse Wants to Keep the Home

If you and your soon-to-be-ex don't want to keep the home, here are some options for avoiding foreclosure.

Sell the Home

If neither party wants, nor can afford, to keep the home, one option is to sell the property. This is probably the easiest way to put the joint debt behind you. Unfortunately, if you're underwater on the loan, it might be difficult to sell the home for a price that will pay off the debt. In this situation, your lender might agree to a short sale or a deed in lieu of foreclosure.

Rent Out the Home

If you find that you're unable to sell the property or complete a deed in lieu of foreclosure, sometimes a viable option is to find tenants for the property and then apply the rental income towards the mortgage loan. The downside to this option is that the divorcing couple remains responsible for the property, as well as the mortgage debt, and will have to work together to manage the rental.

If One Spouse Wants to Keep the Home

If one party in a divorce wants to keep the home, here are some options for doing so and avoiding foreclosure.

Assume the Mortgage

If one spouse wants to keep the house, that spouse can usually assume the mortgage and take over responsibility for the loan.

While many home mortgages have a “due-on-sale” clause, one spouse can generally assume the loan because of a federal law called the 1982 Garn-St. Germain Act. (A due-on-sale clause states that upon a sale or conveyance of the property, then the full loan balance will be accelerated and the entire balance of the loan must be repaid. If the mortgage contract has a due-on-sale clause, the loan usually can't be assumed.)

Under the federal Garn-St. Germain Act, lenders may not enforce a due-on-sale clause if the property is transferred as a result of a divorce decree, legal separation agreement, or a property settlement agreement (even if the mortgage is in default). (12 U.S.C. § 1701j-3(d)). (Learn more mortgage assumptions and due on sale clauses in our article Avoiding Foreclosure: Can Someone Else Assume (Take Over) the Mortgage?)

Though federal law generally preempts state law, the Garn-St. Germain Act gave states that previously had enacted due-on-sale restrictions a three-year window to reenact the previous restrictions or enact new restrictions. Only a few states acted within this window period. Consequently, due-on-sale provisions in documents governed by the law of those states are not preempted by federal law. (For details about the law in your state, talk to an attorney.)

Refinance the Mortgage

If one spouse wants to keep the property, another option is for that spouse to refinance the property in his or her sole name. This way, the co-borrower is released from the debt. In many cases, the terms of a divorce will require one spouse to refinance if he or she wants to keep the home.

Refinancing is generally possible in cases where:

• the mortgage isn't underwater
• one spouse has sufficient credit and income to qualify for a refinance, and
• the other spouse agrees to give up the house.

Refinancing might not be possible if the property is severely underwater or you're already delinquent on payments for your current loan.

Loan Modification

If assuming the mortgage and refinancing aren't viable options, another alternative if one spouse wants to keep the home, but can't afford the current payments, is to apply for a loan modification.

A loan modification is a permanent restructuring of the mortgage where one or more of the terms of a borrower's loan are changed to provide a more affordable payment. With a loan modification, the lender may agree to do one of more of the following to reduce your monthly payment:

• reduce the interest rate
• convert from a variable interest rate to a fixed interest rate, or
• extend of the length of the term of the loan.

If both spouses signed the original loan documents, then both spouses will generally have to sign off on the modification. If one spouse won’t agree, this can kill the deal.

But once a divorce settlement is finalized and one borrower is awarded the property, then that borrower can apply for a loan modification without the other. If that borrower qualifies for a loan modification, the co-borrower might be released from liability on the loan and his or her signature will not be needed, subject to any provisions in the divorce decree. (For example, if the divorce decree states the remaining borrower must refinance to remove the co-borrower from the mortgage, then a loan modification won't be approved.)

When to Hire an Attorney

Coming to an agreement on any of these options can be difficult during a divorce, especially if the separation is contentious. If you're trying to avoid foreclosure during divorce, it's recommended that you seek the assistance of a qualified attorney who can inform you about the different options that are available and can help you dispose of or retain the property.