Foreclosure and Divorce

Divorce and foreclosure often go together. If you find yourself facing a divorce, you might have questions about your current home mortgage, like who's liable for the debt after the divorce and how to avoid a foreclosure.

In this article, you'll learn who's responsible for paying the mortgage and what to do if one spouse wants to keep the home. You'll also learn about options allowing you to dispose of the property.

Figuring out what you want to do with the place early in the separation can help you avoid foreclosure.

Who Is Responsible for Paying the Mortgage?

The first thing that a divorcing couple must first figure out is who's responsible for the mortgage debt. In many cases, when married couples first take out a mortgage, they get the loan and take title to the property jointly.

In other circumstances, one spouse might take out the mortgage and sign the promissory note. Signing a mortgage and promissory note has important legal and financial ramifications.

Suppose both spouses sign the mortgage and promissory note. In that case, they're jointly responsible for repaying the debt and would be liable for a deficiency judgment, if there is one, following a foreclosure (if state law allows lenders to sue borrowers to recover a deficiency).

But if only one spouse signs the promissory note, then that spouse is solely responsible for repaying the debt. That person is the only person the bank may pursue to collect a deficiency judgment after a foreclosure.

If One Spouse Wants to Keep the Home

The next thing that the divorcing couple should consider is who, if anyone, wants to stay in the home and make the monthly mortgage payments. If this subject isn't addressed, both spouses might neglect to make the payments, and the house could slip into foreclosure.

Once you've determined who wants to live in the property and remain responsible for paying the mortgage (and release the other spouse from liability on the debt if legally obligated to pay it), that person can potentially:

• assume the loan
• refinance the loan into their name only, or
• get a loan modification.

Mortgage Assumption

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, the full loan balance may be accelerated. If accelerated, the entire loan balance must be repaid. The loan usually can't be assumed if the mortgage contract has a due-on-sale clause.)

Under the 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)).

Though federal law 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 aren't preempted by federal law. For details about the law in your state, talk to an attorney.

Refinancing the Mortgage

If one spouse wants to keep the property, another option is for that spouse to refinance the property in their sole name to release the co-borrower from the debt. In many cases, the terms of a divorce will require one spouse to refinance if that person wants to keep the property. In doing so, the former spouse is released from the responsibility of making future payments.

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.

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 mortgage loan restructuring where the lender changes one or more of a borrower's loan terms. For example, the lender might:

• reduce the interest rate
• convert the loan from a variable interest rate to a fixed interest rate, or
• extend the length of the loan's term (say from 30 to 40 years).

Once a divorce settlement is finalized, and one borrower is awarded the property, that borrower can apply for a modification without the other. If that borrower qualifies for a modification, the co-borrower might be released from liability on the loan. But if the divorce decree states that the remaining borrower must refinance to remove the co-borrower from the mortgage, then a loan modification probably won't be approved.

If No One Wants the Home

If neither spouse wants the property, a few of the options available to avoid foreclosure include:

Sell the Property

If neither party wants nor can afford to keep the home, one option is to sell the property and pay off the mortgage. Selling the place is probably the easiest way to put the joint debt behind you. But before choosing this option, you need to know your equity value, the costs of selling the house, and the amount of profit you will realize after the taxes are paid.

Unfortunately, if you're underwater on the loan, it might be difficult to sell the property for a price that will fully repay the debt. In this situation, your lender might agree to a short sale or a deed in lieu of foreclosure. (Be aware you might face a deficiency judgment in either of these transactions.)

Rent Out the Home

If you can't sell the property or complete a deed in lieu of foreclosure, another option (in theory) is finding tenants for the home. Then, put the rental income toward paying the mortgage loan.

The downside to this option is that the divorcing couple remains responsible for the property and the mortgage debt and will have to work together to manage the rental. Most divorce attorneys don't recommend this alternative because the divorcing couple would have to decide how to deal with both the rental income and the hassles on the tax returns at the end of the year. Also, decision-making around who to rent to, how to manage the property, and so on often causes issues between ex-spouses.

Hiring an Attorney

Agreeing on any of these options can be difficult during a divorce, especially if the separation is contentious.

If you're going through a divorce and are concerned about your liability for the home mortgage debt, talk to a qualified attorney for legal advice about your particular situation.