What Happens if I Can't Refinance after Divorce?

• Understanding your financial position
• Why refinancing may be denied
• Alternatives to refinancing
• References

A refinance loan allows you to pay off your shared mortgage and assume full financial responsibility for the home you once shared with your spouse. It can be an attractive option if you want to keep your home after your divorce. But refinancing isn't always available. 

Why? Because you’re now down to one household income. Divorce can cause significant financial strain, and sometimes, lenders won’t loan more money to people who seem “risky.” 

If you can’t refinance your mortgage, you still have options. Examining them closely can help you understand which is right for you. First, you need to understand your post-divorce financial picture.

Understanding your financial position

Your debt-to-income ratio (DTI) and credit score are the most crucial factors in refinancing a mortgage.

DTI 

This measures the percentage of your gross monthly income that goes toward debt payments, including your mortgage. It's calculated by dividing your total monthly debt payments by your gross monthly income. For refinancing, lenders typically prefer a DTI ratio of 43% or lower, as it indicates that you can manage additional debt responsibly.

Credit score

Your credit score is a three-digit number that reflects your creditworthiness, based on your credit history. A higher score indicates lower risk for lenders. For refinancing, most lenders require a minimum credit score of 620. A higher score can qualify you for better interest rates and terms.

These two metrics help lenders assess your financial stability and ability to repay a refinanced loan. While other factors might be considered, these are the main two. So, what if they are less than ideal?

Tips for improving your DTI and credit score:

• Reduce debt: Pay down high-interest debts, like credit card balances (even small payments help). Consider consolidating debt to simplify payments and potentially lower interest rates.
• Increase income: Explore additional income streams, such as part-time work or freelancing, to boost your gross income.
• Monitor your credit report: Regularly check for errors and address any discrepancies. Pay bills on time to build a more positive credit history. Pre-scheduling payments can help.
• Build credit: Use credit cards responsibly by avoiding any charges you can’t pay off in full each month or billing cycle.
• Limit new debt: Avoid taking on any new debt, especially large loans.

Improving these metrics may not be possible and takes time, but consistent efforts (even if small) will help you become more eligible for refinancing opportunities.

Why refinancing may be denied

If banks refuse to offer you a new mortgage, you're not alone. About 8% of mortgage applications were denied in 2020, experts say. 

Before issuing a refinance mortgage, lenders assess your ability to repay the funds you borrow. Banks will examine the debt you plan to accept after the divorce compared to the money you'll earn through wages, tips, and investments. If your debts are so high that you'll struggle to pay them on your new single income (including any alimony paid or received), refinancing may be difficult. 

How divorce affects refinancing:

1.  Income changes: Divorce often reduces one’s household income, making it harder to meet the income requirements for refinancing.
2.  Credit impact: Divorce can lead to missed payments, increased debt, or a lower credit score, all of which negatively impact your ability to refinance.
3.  Lender risk assessment: Lenders may see recently divorced individuals as higher risk due to potential financial instability.

If you've visited several banks and they all refuse to offer a refinancing mortgage, it's time to examine other options. Several are available, including the following.

Want to talk through your options? Schedule a free call with our real estate expert.

Alternatives to refinancing

If you can't or prefer not to refinance, here are your options.

Consider a release of liability

First, you’ll need to understand how releasing a party from the mortgage affects loan terms, especially interest rates and payments. The remaining borrower must ensure they can handle the mortgage alone, as their credit will be solely responsible for the loan. Lenders typically require the remaining borrower to refinance the mortgage to remove the other party, ensuring they meet income and credit requirements.

Contact the bank that manages your current home loan and tell them about your divorce. Explain that you'd like to take on full liability for future mortgage payments and that you'd like a formal document that removes your spouse from the mortgage. 

This document ensures that your spouse won't be liable for any payments you miss, and it could make the offer both fair and more attractive in your divorce settlement. 

Liability release isn't always an option. Some lenders, like Fannie Mae, will only issue a release if you can prove you can repay the mortgage alone. If you're struggling to get a refinancing mortgage, you could face the same problems here. 

Mortgage assumption

Ensure that the lender agrees to the mortgage assumption, as not all loans are assumable. You’ll need to meet income, credit, and other financial requirements. The assuming spouse becomes solely responsible for the mortgage, so confirm that you can manage payments independently. Consider whether you need to buy out your ex-spouse's equity in the property, which might require additional financing. 

Outline of the mortgage assumption process:

1.  Contact the lender: Inquire if the loan is assumable and get lender approval.
2.  Submit application: Complete the assumption application, providing the required financial documentation.
3.  Credit check: The lender will review your credit score and history.
4.  Income verification: Prove that you will have sufficient income to cover mortgage payments.
5.  Sign assumption agreement: Legal documents are then signed, transferring mortgage responsibility to the assuming spouse.
6.  Title transfer: Update the property title to reflect the new ownership.

Financial qualifications needed:

• Credit score of 620 or higher
• DTI should be below 43%
• Proof of enough income to manage the mortgage independently

Ask for more time

Maybe you just need time to sort things out. If so, ensure any extension is documented in a legal agreement, outlining the new deadline and conditions. Maintain open communication with the lender, explaining your situation. Note that the delay might affect your credit score, mortgage terms, and relationship with your ex-spouse.

Creative solution in your settlement

If you can't get a new mortgage or a release of liability, you could enter a formal agreement with your spouse as part of your divorce settlement. You will agree to make all mortgage payments on time, under the current mortgage arrangement, until such a time that your credit score improves and you can get a new mortgage. 

If you're in an emerging market, this could be enticing for your spouse. You'll stay in the home and make payments, and somewhere down the line, your spouse will get a payout when you refinance. That wait could result in big dividends. 

If your spouse isn't willing to wait, you may be able to incentivize the deal. For example, you could find out how much your home is worth right now and trade assets so you can keep the house. 

Let's say the value of your retirement account is $30,000. If both you and your partner have money set aside for retirement, you could give your spouse the amount in both accounts in return for the home. 

In a deal like this, your spouse would have to wait until your credit score or financial future improves enough to allow for a refinance. There are risks involved. But this plan is fair and could allow you to keep your home. 

Buy out now

You can calculate the buyout cost, including remaining mortgage balance and your ex-spouse's equity. Get a professional appraisal to establish the current market value and ensure a fair buyout. When you’ve become the sole owner, update the title and mortgage documents.

Sell your home

Sometimes, it makes sense to let go of the marital home. A home sale formally breaks ties between you and your spouse. You both share the profits, and you could use them to buy a new property you love and can afford. 

To do so, assess current real estate market trends to determine the best time to sell and maximize your sale price. Understand your home’s equity and how much you’ll net after paying off the mortgage and related costs.

Factor in real estate agent fees, closing costs, and potential repairs or staging expenses. Arrange for alternative housing, considering both temporary and long-term options.

It might be wise to consult with a lawyer and tax advisor to understand the impact of selling, especially regarding capital gains and division of proceeds.

Selling a home may seem difficult, but surveys suggest just 25% of people miss their home after the sale. Most people find new spaces to love, and they often like their new home more than their last.

Final thoughts

During a divorce, almost every part of your life is changing. It's reasonable to hold tightly to your home, as it's one thing that seems both safe and familiar.

Work closely with your partner, and you could develop a divorce settlement that is fair and acceptable to both of you. You could potentially keep your home with these agreements.

But if you can’t keep your home, know that another one is out there waiting for you to find it. Want to talk through your options? Schedule a free call with our real estate expert.

References