When your home is underwater -- when you owe more on the mortgage than the property is worth -- it can complicate your divorce tremendously. You and your spouse must not only divide your assets when you break up, but your debts as well. A home with negative equity falls into both categories.
Exchanging Debts and Assets
When one spouse keeps the home and assumes responsibility for the negative equity, courts in some states will compensate him for the extra marital debt he’s taking on. For example, if the home appraises at $200,000, and if the mortgage against it is $220,000, the spouse who keeps the home finds himself responsible for $20,000 in marital debt. Only $10,000 of this is rightfully his; the other $10,000 should be his spouse’s responsibility. Some courts balance this by awarding him an additional asset worth $10,000. Alternatively, a judge might assign the spouse not keeping the home an additional $10,000 in debt, such as by obligating her to pay off credit card debt in that amount.
Ignoring the Negative Equity
Judges in some states are reluctant to adjust the division of debts and assets to achieve a balance when one spouse keeps the marital home and its mortgage is underwater. If the spouse retaining the home holds onto it long enough for the market to spring back, he may not be assuming extra debt at all. When the market rebounds, the home is worth more, and the $20,000 in negative equity no longer exists. Additionally, if the home appreciates in value enough, he might eventually end up with more in the way of marital assets than his spouse did. Some courts will essentially ignore the negative equity for this reason. A judge might divide marital assets and other marital debts as if the home was worth exactly the same as the mortgage against it.
Erasing the Negative Equity
Spouses might also elect to relinquish the home to erase the debt. A judge is not likely to order this recourse as part of property division, but when spouses negotiate a property settlement, the judge will usually approve it. You might eliminate your negative equity by agreeing to negotiate a short sale with your lender. The lender will allow you to sell the property for less than the mortgage, typically for a price comparable to its current fair market value. The deficiency in equity might show up on your respective credit reports. Thus, you’ll need ammunition when you approach your lender, such as one or more appraisals indicating the home’s reasonable market value. You can also sign the home’s deed back over to the lender in lieu of foreclosure. This may result in a blemish on your credit report as well. In both cases, you should make sure the lender erases the deficiency so you’re no longer legally responsible for it.
Waiting Out the Market
You and your spouse might decide to wait out the market and reserve division of your home’s debt and equity for a later time. Some states, such as California, will allow you to bifurcate your divorce. This means the court terminates your marriage, but issues such as property division and custody remain open. You might be able to wait and divide the home's value later when the negative equity is eliminated or not as significant. Even if your state doesn’t recognize bifurcation, you can agree in a marital settlement agreement that you’re going to retain the home until the market turns around or you’ve built up additional equity. However, you’d have to also agree on who’s going to pay the mortgage until that time, who’s going to live in the home, or if you’ll rent it to cover most -- if not all -- of the monthly expenses associated with it.
- Hamilton, Judge, Schroer & Steingold: Divorce and the Underwater House
- Paul R. Panico: How to Divorce With an Underwater Mortgage, Part One
- National Law Review: Divorce – What to Do With a House That’s Underwater?
- Reisman & Davis: Divorce and “Underwater” Mortgage Debt
- Roy M. Doppelt & Associates: Marital Status