Don't Assume the Assumption!
One of the bright spots of the COVID-19 inspired global pandemic was the sharp decrease in mortgage rates. After all, bad news for the economy is good news for mortgage rates (and vice versa). The historic spike in unemployment filings and sharp decrease in consumer confidence clearly qualified as “bad news” and subsequently led to the lowest mortgage rates we are likely to experience in our lifetimes. Suffice to say, nearly everyone either locked in these reduced interest rates via mortgage refinances or brand new home purchase loans between the years 2020 - 2022.
Included in the population who have locked in these low rates are married homeowners who are now seeking divorce. In the event one of the divorcing parties wishes to retain ownership of the marital home (whom we will refer to as the “In-Spouse”), there is an overwhelming desire by them to hold onto the existing mortgage rate, as opposed to securing current-market interest rates which are likely more than twice the cost. As we are all aware, mortgage rates directly impact the Principal + Interest (P+I) portion of the mortgage payment, and seemingly everyone desires the lowest mortgage payments possible.
These stakes are raised even higher in the event the In-Spouse is seeking to pull additional money out to make the departing spouse (aka the “Out-Spouse”) whole via a Divorce Equity Buyout.
Sample Case Study
Let’s say for example that the marital home value is $500K and the existing mortgage has a current interest rate of 2.750% with a balance of $400K (resulting in equity of $100K). In exchange for relinquishing both ownership & occupancy of the marital home, the Out-Spouse demands to be removed from the existing lien ($400K) and receive 50% of the $100K in equity ($50K). The In-Spouse would then be seeking a brand new loan of $450K. For simplicity, we are excluding all Non-Recurring Closing Costs (NRCC’s) and Recurring Costs (RC’s) from the above calculations.
If the existing qualifying rate was say, 6.750% for the $450K new mortgage loan, the monthly payment would be significantly higher for the In-Spouse when compared to existing 2.750% on an existing loan with a balance of $400K. This “payment shock” may be more profound if there is currently a dual-income family separating into a single-income family who is now responsible for a considerably higher mortgage payment.
Can the In-Spouse “Assume” the Existing Mortgage?
Enter the concept of a Mortgage Assumption. In a perfect world, the In-Spouse would be able to not only retain the 2.750% rate on the existing loan, but they would also be permitted to pull the extra $50K out at the same 2.750% rate…all while simultaneously removing the Out-Spouse from obligation to pay the existing loan. While this scenario would be ideal for the Consumer, the Lender will not acquiesce to such a concession as their loyalty is devoted to stakeholders and/or shareholders associated with the company. As fellow professionals, let’s all agree definitively that these dynamics are NOT an option, despite the fact that we constantly hear about Mortgage Assumptions being a viable solution to combat higher current market rates.
Legal Transfer Assumption versus Qualified Assumption
The Divorce Lending Association, which certifies Mortgage Professionals as Certified Divorce Lending Professionals (CDLP’s) defines an assumable mortgage as “a type of mortgage loan that can be transferred by a seller and ‘assumed” by the purchaser of the parcel of property to which the mortgage is attached. When such a situation occurs, the purchaser will become responsible for paying off the remaining balance of the mortgage loan”.
While the above definition references a “purchaser” who is buying the home from the existing homeowner, the same definition may also be used with a party who is “retaining” the existing home…especially in the event of a divorce. Regardless of the association of the parties involved, it is imperative to note that there are 2 types of assumptions, which are as follows:
A “Legal Transfer Assumption” (aka a “Simple Assumption”) allows one party to assume legal responsibility to make payments on an existing debt, while positioning the existing Borrower to remain as a Guarantor in a secondary position (similar to a “co-signer” on a loan).
A “Qualified Assumption” (aka a “Novation”) allows one party to not only assume the legal responsibility to pay the debt, but it also relinquishes the departing Borrower from any future obligations on the existing debt (which is memorialized via a “full release of liability” agreement). Of the 2 types of assumptions, the Qualified Assumption is ideal for the departing party on the existing contract, but it is much more difficult to attain.
What is an Exempt Transfer?
The Garn St. Germain Act of 1982 (GSG), prohibits lenders from exercising the “Due on Sale Clause” amidst an exempt transfer (such as death or divorce). The heir or spouse awarded the home (new owner) legally assumes responsibility for paying the current mortgage and becomes classified as a Successor Of Interest (SOI). In the context of divorce, the SOI is awarded the home in full via the marital settlement agreement, and can continue making payments to the existing mortgage without the need to refinance it. This dynamic comes into play whether the SOI was a co-borrower on the existing loan (and the departing spouse transferred his/her ownership to the SOI), or in the event the departing spouse was the only guarantor on the existing mortgage and transferred the obligation to pay the existing mortgage to the SOI. The takeaway here is that even if the SOI was not on the existing loan, the lender cannot accelerate the Due on Sale action (as notated in the Alienation Clause of the contract) in the event of a divorce, which is qualified as an exempt transfer.
With the above dynamics in mind, it is the responsibility of the SOI to notify the existing Lender in writing about the divorce. Please contact the author of this article for specific verbiage to utilize, and recommended documentation to provide in order to prevent the SOI from receiving an uncomfortable notice from the Lender to pay the existing mortgage in full within 30 days.
Contingent Liabilities
There is a myth with the legal transfer assumption that the vacating spouse will not be able to qualify for new financing due to the need to count 2 different housing debts against his/her debt-to-income (DTI) ratio. There is a method to omit the loan on the marital home from the DTI ratio obligations of the departing spouse for loan qualifying purposes.
The verbiage in the settlement agreement is crucial in order to make this happen, as the goal is to declare the marital mortgage as a Court Ordered Assignment of Debt. In other words, the courts are assigning legal obligation to make the mortgage payment to the In-Spouse. Mortgage Originators refer to this process as creating a contingent liability, which may be excluded from DTI ratio calculations. It bears noting however, that if the In-Spouse fails to make a timely mortgage payment, both the In/Out-Spouse are liable (and both of their credit reports will receive the detrimental reporting and subsequent credit scoring implications).
Are All Mortgage Loans Assumable?
Not all Mortgage Loans are assumable! Typically, loans administered through The Department of Housing & Urban Development (HUD) are assumable, which include FHA, USDA, and VA loans.
An important distinction to note with VA loans is the VA entitlement benefit necessary to access the program. With regards to assuming a VA loan, either the party assuming the loan must have sufficient VA entitlement, or the assuming party will tie-up the VA entitlement for the departing party, which most Veterans will be unwilling to entertain.
Additionally, you may see Adjustable Rate Mortgage (ARM) loans feature assumption clauses. It is best to check for mortgage assumption eligibility on the Promissory Note, the Deed of Trust, and/or the Closing Disclosure (CD) which accompanied the creation of the existing loan seeking to be assumed. The majority of loans created during the 2020 - 2022 period were low fixed rate, non-HUD loans (so temper your expectations on which loans will be eligible).
Furthermore, if there is an existing 2nd Mortgage on the subject property (i.e. a Home Equity Line of Credit), a mortgage assumption is not allowed. If the existing mortgage has Private Mortgage Insurance (PMI), the mortgage assumption must be approved by both the existing mortgage company and the PMI company.
How Can You Quickly Determine If A Loan Is Assumable?
One of the final Loan Documents a Borrower received at the conclusion of the loan process is the Closing Disclosure (CD). The CD has a separate area that addresses the eligibility for this particular loan to be assumed, and looks as follows:
Implications Amidst a Divorce Equity Buyout
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