Can You Use a Home Equity Loan in a Divorce Settlement?

If you’re a homeowner going through a divorce, you’ll need to divide your home equity as part of your divorce settlement or separation agreement. You can’t use a home equity loan to do this, but there are other options available that involve tapping your home equity.

A home equity buyout — also known as a “divorce refinance” — can help you split your equity when one spouse wants to keep the house. Here are four steps you should take as you decide how to divide the equity, how each person receives their share and whether you’ll need to apply for a new mortgage.

#1. Determine how much equity you have

Before you decide how to handle equity in a divorce settlement, you’ll first need to figure out how much home equity you have. Home equity is the difference between your home’s value and any outstanding loans or liens. Below are the two most common ways to calculate home equity:

1. Ask a real estate agent to prepare a comparative market analysis (CMA). A CMA estimates your home’s value by comparing it to similar homes nearby that were sold recently. A CMA is typically prepared by a real estate agent.
2. Get a home appraisal. A home appraisal is a more detailed evaluation of your home’s value and must be prepared by a licensed appraiser. An appraisal usually costs between $300 and $500, and most lenders require them for mortgage financing.

 Try using a home equity calculator to estimate how much you could borrow.

#2. Decide who gets the house in the divorce

If either you or your ex want to remain in the home alone — and especially if both of you want to — you’ll need to negotiate which of you will keep it. Here are two important financial questions to answer before you decide who gets the home:

 Who can afford the monthly payment? It can be a shock to suddenly shoulder a mortgage payment on your own if you’re used to being in a two-income household. If the house will be in just one person’s name after the divorce, that person will need to qualify for a new mortgage based on their individual income.

Who can handle maintenance and repairs? Many experts suggest budgeting 1% of a home’s value each year for upkeep. Whichever spouse ends up with the house might want to consider buying a home warranty for extra insurance against major issues with costly appliances or home systems. The extra $20 to $150 per month may be well worth it if the home is older and likely to need repairs.

 Use our home affordability calculator to help figure out how much house you could afford.

#3. Agree on how to split the equity

Although divorce attorneys typically decide how to split the equity as part of your final divorce decree, where you live, how you came to own the home and how you hold title to it may come into play. Here are some common ways of splitting your assets in a divorce:

In general, you’ll divide your home equity evenly if you own a home in a community property state. There are currently nine states in the U.S. that treat a divorcing couple’s property as community property: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.

In equitable distribution states, how you divide your property is based on what a judge views as “fair” given the specifics of your situation. A fair arrangement won’t necessarily be one in which everything is split equally. For instance, if you inherited a home, in an equitable distribution state it’s usually awarded to you.

There are several different ways to take ownership (or “title”) of a home. Taking legal ownership is also known as “vesting.” Each title vesting option gives you different rights to use the property and, in some cases, may restrict how much ownership (or “interest”) you have. For example, tenancy in common is a type of vesting that allows multiple people to co-own the home without having equal interest.

Your agreement doesn’t have to match the default law in your state

You and your spouse are free to come to any agreement for splitting your equity that makes both of you happy. However, a judge must approve it before you can finalize the divorce — so, if it’s grossly unfair to one party, you may run into roadblocks. And if you can’t agree at all, a judge will ultimately have to make the decision for you using your state’s default approach (that is, either equally or equitably).

#4. Determine if you qualify for an equity buyout

If you’re awarded the home in a divorce, you may have to “buy out” your spouse’s portion of the equity. If you don’t have enough cash to cover the buyout, you may want to convert some of your home equity into cash using an equity buyout loan.

An equity buyout, also known as a “divorce refinance,” is a special purpose cash-out refinance used to tap as much equity as you need to pay your spouse’s home equity share. You typically can’t pocket any extra cash; it all has to go toward buying out your ex-spouse.

You’ll have to qualify for this loan on your own, so make sure you brush up on the minimum mortgage requirements for different loan programs. Here are some general guidelines:

• Maximum loan-to-value (LTV) ratio. Your LTV ratio is a measure of how much you can borrow compared to your home’s value. Most equity buyout loans allow you to tap up to 80% of your home’s value (or 65% for a manufactured home). However, if you’re a military borrower, you can boost your LTV up to 90% of your home’s appraised value with a loan backed by the U.S. Department of Veterans Affairs (VA).
• Maximum debt-to-income (DTI) ratio. Lenders look at your total debt, including the new mortgage payment to determine your DTI ratio. Depending on your loan type, you can typically qualify for an equity buyout loan with a DTI as high as 41% to 45%.
• Credit score minimum. A conventional loan requires at least a 620 credit score. You may need a loan backed by the Federal Housing Administration (FHA) if your score is between 500 and 619.

 Don’t know your credit score? Get your free score on LendingTree Spring.

Equity buyouts may require special documentation

You may have to provide documentation proving that you owned the property for at least one year, that you lived in it with your spouse and that all parties involved are on board with the buyout loan. In fact, in some cases if your divorce settlement doesn’t include language about the equity buyout, you may not qualify for one at all. Instead, you’d have to utilize a generic cash-out refinance.

What happens if I can’t refinance after divorce?

If you’re unable to refinance your home after a divorce, there are three other options you could choose:

 Sell your home to protect your equity from a potential foreclosure.

 Defer the home sale and co-own the house. A deferred sale, which is when both people continue to co-own the house but only one continues to live in it. This can make sense for families who want their children to be able to remain in the home, or for couples who divorce during an especially bad time for the housing market.

 Remove one spouse’s responsibility for the mortgage. If one spouse wants to avoid refinancing and remain in the home permanently, things can get messy. Removing someone’s responsibility for paying the mortgage debt — as well as their ownership in the home — is far more complicated without the refinance, but can be accomplished in one of two ways:

1. Removing responsibility for the mortgage debt with lender approval
   There are only a few options for removing a name from the mortgage without refinancing. You’ll have to get the lender’s approval, have one spouse assume the mortgage or have the departing spouse declare bankruptcy.
2. Transferring ownership
   It’s possible to transfer title to another person using a document called a deed. You aren’t required to have a lawyer help you create a deed, but it’s a good idea to consult one anyway — they’ll make sure you abide by the law in your state.