A House Divided: Dealing with your home in divorce (Part 2)

By Jennifer M. Paine

home

Attorney, Cordell & Cordell, P.C., Detroit office

Note: This is Part 2 of a two-part series. Click here to read Part 1.

In today’s downward economy, with home foreclosures having been at their highest, many couples face a common predicament; their mortgages exceed their home’s value. They cannot afford to sell, but they cannot stand to live together. Neither wants to assume the mortgage debt. Or neither can. They ask what they can and should do. Here are some suggestions.

Mortgage Traps for the Unwary

Blissful, young newlyweds on a let’s-build-a-nest high, you and your spouse purchased a half million dollar house with zero down on a thirty year mortgage with a balloon payment. Ten years later, the bliss has soured and you both want out, but the house is worth $300,000 and you’ve barely made a dent in the principal. So, your house is “underwater.” Now what?

 

If you are facing foreclosure. If you cannot repay your mortgage loan, your lender (or, more likely, the lender’s assignee) may begin the foreclosure process pursuant to the terms of your mortgage and federal and state law. If you face a foreclosure, contact your lender and request a meeting immediately. At the meeting, discuss what options you have to delay the foreclosure. These may include forbearance, refinancing, a longer redemption period in the event of foreclosure, a new payment schedule, and a short sale. Be proactive. Do not wait for a foreclosure notice to contact your lender or hope that your divorce will shift the debt to your spouse. Usually, it will not. Explain your legal and financial problems to your lender, and ask for reprieve. Bring financial documents, such as bank account statements and paystubs, to substantiate your financial predicament. The lender may or may not be able to sue you to collect any deficiency between the bid at the foreclosure sale and the outstanding balance on your loan. The terms of the loan will specify whether the loan is a recourse loan, rendering you liable for the deficiency, the notice, if any, required before beginning the foreclosure process, and any other rights you have independent of federal and state law to stop the foreclosure. Request a copy of your entire mortgage and note file. Read it thoroughly and make sure your lender is following every duty to a T (Was notice proper? Do you have an opportunity to cure the default? Is the note a recourse note?) Most lenders are willing to work with you if you are sincere and in good faith negotiate a repayment plan because lenders would rather have an income stream than an empty house. 

If you can negotiate a short sale. In a short sale, the lender agrees to accept less than the borrower’s mortgage indebtedness when the borrower sells the property to a third party in an arm’s-length transaction. Lenders usually agree to short sales to avoid the costs of foreclosure and having a large inventory of empty, unsellable homes. However, short sales come with their own costs. First, as a matter of contract law, a lender may pursue a deficiency if the short sale approval is not conditioned on the lender waiving the deficiency. Therefore, be sure to condition any short sale plan submitted to your lender for approval on the lender waiving any deficiency. Second, the short sale approval process is long and tedious; you and your potential buyer must be willing to wait. Large lenders have short sale packets for use. They include forms for, inter alia, comparative market analyses and brokers’ price opinions, hardship letters, financial disclosures, authorizations to release information, listing agreements, and proposed sale terms. If your lender does not, you will have to obtain these materials. A real estate agent and/or a lawyer experienced in real estate law should be able to assist you. Third, if the lender does approve the short sale and waive any deficiency, the forgiven debt may trigger income tax liability. The lender must send the borrower Form 1099-C, Cancellation of Debt, to indicate the amount of debt forgiven. If the debt was for a principal residence, under the Emergency Economic Stabilization Act of 2008, until 2013 borrowers may exclude the forgiven debt from gross income for federal tax purposes. There is no dollar limit on the exclusion if the principal balance at the time the lender forgave/cancelled the debt was less than $2 million for a couple filing jointly or $1 million for a borrower married but filing separately. Otherwise, the debt may be includable in gross income for tax liability calculations.[1]

If you deed the house to one spouse. If your court awards you or your spouse your home, the award does not, absent more, affect each spouse’s liability on the home mortgage. Because the lender is not a party to your divorce, the court cannot adjudicate the lender’s rights to repayment. Careful drafting in the divorce decree and all deed documents is an absolute must to avoid unintended liability. For example, in Marrow v Marrow,118 NC App 332; 454 SE2d 853 (1995), the North Carolina Court of Appeals held that a deed to a spouse “assuming the mortgage,” absent more, did not mean the spouse agreed to relieve the other spouse from liability on their home mortgage because (1) the spouse took no further action (e.g., by making full payments) and (2) the parties’ decree awarded the house to the spouse but required each of them to pay the mortgage until the house sold. To protect the non-taking spouse, the decree should require the taking spouse to refinance the mortgage into the spouse’s name immediately; if that is impracticable, the decree should impose on the spouse a continuing duty to apply for refinancing in good faith until successful and, in the interim, to hold the non-taking spouse harmless for any mortgage default and the costs thereto (e.g., interest or penalties). The decree should specify each spouse’s responsibility for property taxes, insurance, homeowners’ association fees and any other liabilities until the home is refinanced or sold. The decree should specify what recourse the non-taking spouse has against the spouse in the event of default, such as liquidated damages, a default judgment equal to the amount of the mortgage or other liabilities the non-taking spouse has to pay, mandatory attorney fees and/or contempt.

If your only feasible option is to do a Walter-and-Anna and divide the home in half, each living on one side of a giant white line, be sure your decree specifies, in minute detail, what you will do until the home sells. At a minimum, the decree should include specific language for who will pay the mortgage, the taxes, the insurance, the utilities, and any other liabilities, when and how you will list the home for sale, and what you will do with the sale proceeds. Include language requiring each of you to act in good faith, to prepare and execute all documentation reasonably necessary for the sale and incident to the sale, to exchange reasonably necessary financial information, and to cooperate to maximize the tax advantages of the sale between the two of you. This may mean splitting any tax refund and/or sharing the costs for the sale, for preparing tax documents, or both. If your spouse refuses to comply when you are ready to sell, you will have an enforceable order to compel compliance. Keep the home neat, in good repair and “show-able” for potential buyers ––

— and hope for a quick sale before your house falls apart like a money pit, too.


[1] Tax liability for short sales is in addition to the tax consequences in IRC 1041 (for sales and other dispositions incident to divorce) and IRC 71 (for includability/deductibility of certain periodic payments in a divorce decree or other written separation agreement). These tax issues go beyond the scope of this article. You should contact a tax attorney and/or your financial advisor for a thorough assessment of the tax laws applicable to you. IRS Circular 230 

 

Note: This is Part 2 of a two-part series. Click here to read Part 1.


Disclosure: To ensure compliance with requirements imposed by the IRS, be advised that any federal tax advice contained in this article was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Always consult a specialist for thorough tax advice.



Jennifer M. Paine is an Associate Attorney in the Detroit, Michigan office of Cordell & Cordell P.C. She is licensed to practice in Michigan, and has been admitted pro hac vice in Illinois, Ohio, and the United States Court of Federal Claims. Ms. Paine received her BA in English and Mathematics from Albion College and graduated Summa Cum Laude. She received her Juris Doctorate from MSU College of Law and graduated Summa Cum Laude.

 

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