After a divorce, it is quite common for one of the spouses to remain in the marital residence, creating the need to “buy out” the other spouse’s interest in the home. This is often accomplished through a refinance transaction—in order to remove the departing spouse from the home as well as to generate cash to pay off the departing spouse.
In times past, this refinance was treated by lenders as a “cash out” refinance, and thus subject to a higher interest rate and stricter limits on the loan amount. The reason for this is people who take cash from their homes have a statistically increased risk of foreclosure. Many of those folks are spending the cash on home improvements or even a variety of toys, but the facts show that they often get overextended beyond their means. To compensate for that increased risk, lenders historically charge a higher interest rate for getting cash out, regardless of the reason behind it.
More recently, however, the government agency Fannie Mae—which is in charge of setting the rules for residential lenders—has taken a closer look at the nuances behind cash-out financing. Fannie Mae concluded that certain situations (such as divorce buy-outs) do not actually constitute an increased risk of foreclosure. Hence, divorce buy-outs are no longer considered a “cash out” loan and they are no longer subject to the corresponding interest rate adjustment.
This is good news for recently divorced folks looking to save money!
Also, the loan amount for a divorce-based refinance can now go up to 95% of the value of the home (for a conventional loan). Historically, a divorce “cash out” refinance could not exceed 80% of the property’s current value. With decreasing home values over the past few years, such a restriction meant that many divorced folks simply could not refinance—putting the financial and home separation process into an awkward limbo.
Keep in mind an important exception, however. If the cash from the refinance is being used to pay off credit cards, then the loan is still viewed under the old guidelines. The new guidelines apply only when the cash is for paying off another spouse per the divorce decree. With lower costs and more flexible criteria, these new financing rules are a welcome change to those already in the midst of a difficult process.
Jeff Koch is a mortgage lender with over 10 years of experience. He works for 1st Advantage Mortgage—a subsidiary of Draper and Kramer. Prior to that, Jeff spent several years as a full-time Realtor in Chicago. He enjoys helping people secure the best and most affordable financing options for their unique situation. Seeing each individual as valuable, Jeff’s goal is to provide “Absolute Integrity and Unparalleled Service”. Learn more about Jeff from his website: www.singingmortgageguy.com.