Divorce, and a House with No Equity (or Negative Equity)

Posted by & filed under Divorce.

Six to ten years ago, nearly every divorce in which the couple owned a house provided the couple some equity value to divide.  The house was an asset, and the spouses could sell the house, and divide the proceeds; or one of the spouses would buy out the other spouse’s interest in the house.  In the latter case, one spouse would be given a financial settlement for the asset he or she would be leaving behind.

Then there was a housing bust that caused scores of foreclosures and short sales.  Many economists believe that we may be climbing out of that hole, and the housing market is improving.  But that does not change the reality for many divorcing couples that their house has value at or below the balance owed on their mortgage.

In the case of a house with negative equity, if one spouse leaves the house behind, the other spouse is left, not with an asset, but with a liability.  The spouse left with the liability may believe that the departing spouse should pay something towards the debt on the house.  The problem with that idea is that the house may end up in foreclosure, or a short sale, or the spouse who stays in the house may be able to negotiate with the bank on the mortgage.  In other words, the spouse who stays may not end up realizing the entire “negative value,” so to receive from the departing spouse a “full accounting” of the negative value may result in something of a windfall to the spouse who stays.

Moreover, if the couple has children, one spouse may stay in the house to avoid, or delay, the children’s move to another house.  In so doing, that spouse derives intangible benefit, essentially an unquantifiable value, from remaining in the house – particularly if that spouse is able to negotiate with the bank, and is able ultimately to remain in the house, with the children, indefinitely.

The most common practice is to treat the “underwater” house as a “zero asset.”  The departing spouse is incurring the expense of renting, which offsets the expense to the remaining spouse to continue to make payments on the mortgage.  In the case of a home with a larger mortgage payment, the remaining spouse may leave the house after the expiration of the mortgage redemption period, without putting any additional money into the home.  Either way, assigning a zero value to the house is often found to be the fairest resolution.

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One Response to “Divorce, and a House with No Equity (or Negative Equity)”

  1. TJ

    If I may ask for clarification on this posting: are you inferring that a marriage dissolution would outright remove the liability of a party from a mortgage? I am unfortunately just wading into the waters of divorce, but had always operated under the impression the mortgage company would have to approve the removal of a party from the loan. This is problematic, because my (ex)wife misses the calculated income level to assume the mortgage outright by about $2000 a year (so she can very realistically afford the loan on her own, just not in the eyes of the underwriters). I’d rather not continue to live with someone whom does not wish to live with me until a short sale can be processed, so if the dissolution can allow for the house to be retained by my wife while insuring that I have 0 liability to the debt, that would solve the #1 problem I have. Thanks for your knowledge on the topic, your postings are quite informative!

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