In divorce, one of the most difficult decisions is what to do with the family home.
Take the story of Jill and Bob Carter. The Carters have been married for 20 years and purchased their home after marriage. The home is considered community property. The Carters have two children, Mark, 18 and headed to college, and Sarah, age 15. Jill says she wants to stay in the home for the stability of the children. Jill works as a senior public health administrator with a salary of $120,000. Bob is an engineer at a large corporation with an annual salary and bonus totaling close to $250,000.
The Carters purchased the home for $400,000. The spouses agree that the home’s value is about $1,100,000. Minor improvements were made to the home over the years. The cost basis of the home is $450,000. The taxable capital gain on the home is $650,000, less exemptions available for residential homes (more on this below).
The Carters borrowed against their home equity via a cash out refinancing five years earlier. The mortgage balance on the home is $350,000 at 4%. Therefore, the home equity at the time of divorce is $750,000. The mortgage payment is $1,845 plus $1,500 escrow for property taxes and homeowner’s insurance, for a total monthly payment of $3,345. Since Jill will have primary custody of Sarah, Jill expects to be awarded $1,500 per month in child support.
Jill stays in the home. The home is co-owned by Jill and Bob until Sarah graduates from high school. Then they will sell.
Bob has several concerns about this plan. Will Jill be required to maintain the home? If Bob is responsible for half the payment of repairs, how will they agree on what is necessary, who will do the repairs and at what cost? He is also concerned that Jill will be unable to cover the mortgage. She doesn’t take ‘paying the bills’ as seriously has he does, and her income and credit score are not good enough to refinance the debt. What happens to his credit if she misses a mortgage payment? Even worse, what will happen if Jill’s new boyfriend moves in? Bob is also concerned about whether the mortgage will impact his ability to purchase and finance a home himself. Bob should talk to a lender experienced in divorce before he makes any decisions.
Jill is concerned about having enough income from her job and child support to cover the mortgage payment. She has never managed money or the bills. Bob always took care of that.
Under this plan, both parties benefit from the home’s growth in value. This plan also may preserve the $500,000 capital gain tax exemption upon the sale of the home.
Jill is awarded the home. Bob will take other assets but there not enough assets to make the division equal.
This scenario addresses some of Bob’s concerns. He no longer worries about whether the home is being repaired or the cost to maintain it. However, since Bob’s name is on the mortgage, he’s still concerned about whether Jill will make the required mortgage payments. He is also concerned about whether the mortgage will impact his ability to get a mortgage and purchase a home himself. Bob should talk to a lender experienced in divorce before he makes any decisions.
Under this plan, only Jill will benefit from the home’s growth in value. This plan also does not preserve the $500,000 capital gain tax exemption upon the sale of the home. The exemption will be reduced to $250,000. Losing this exemption costs an additional 15% of the exemption lost or $37,500. Should this be factored into the value of the house when dividing the home and other assets or does benefitting from the growth of the home’s value offset this cost?
In order to compensate for the lack of other assets to award Bob half of the value of the marital estate, Jill gives Bob a Promissory Note, a sort of an IOU, to make up the difference. The terms of the Note are negotiable. Jill may be required to make regular payments of principal and interest or interest only payments with a final payment due upon the earlier of (a) five years’ time or (b) the sale of the home. Interest can also be accrued (meaning no payments are made until the earlier of (a) five years’ time or (b) the sale of the home), which helps Jill’s monthly budget. However, the Note brings back Bob’s concerns about Jill’s ability to maintain the home in good working condition. And another issue: the existing mortgage makes it unlikely that Bob will be able to secure the Note with the home as the underlying asset.
If the home is not sold within five years, Jill will be required to pay off the Note using other resources or to sell the home in order to pay off the Note. Bob will ask his attorney to add the right to force the sale of the home if the Note is unpaid after five years. Jill thinks that in five years her pay will have increased enough to make her feel comfortable covering homeowner expenses, and if not, she believes her parents or siblings may be able to help.
The number and complexity of variables needing to be considered when keeping a family home cause many divorcing couples to decide to sell the home when a sale is possible. Without an outright sale, couples will need to be flexible, and sometimes generous, in order to make keeping the home a viable option.
Adding a Certified Divorce Analyst and a qualified mortgage lender to the mix of professionals involved in the divorce process can add a fresh perspective. These professionals will help identify the financial options available to make the choices workable.
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