Divorce Financing Meets a Turbulent Real Estate Market |  Fox Rothschild LLP
Divorce Financing Meets a Turbulent Real Estate Market |  Fox Rothschild LLP

Ultimately, divorce is a financial transaction surrounded by complex human emotions. Part of the divorce attorney’s mission is to try to gently unpack the emotion so that each party can walk away from a failed relationship with assets that make sense.

Childcare is the most difficult part of the problem. Each parent tends to see themselves as the “better” or “more stable” parent. But custody disputes are often linked to housing disputes. Almost any parent would agree that children are the innocent victims of divorce. But things get complicated when parents start asking, “Well, why should the kids move out?” Doesn’t that just add to the turmoil? »

Absolutely, the answer is yes. But our world has very few absolutes and, as we will demonstrate, the market can hurt you badly while you try to do what you think is “by the kids”.

In happier times (2003), our client and his wife bought a house for $300,000. Now things are not so happy and the question is how to unbundle family assets in the most efficient way. For the sake of simplicity, let’s assume a 50/50 split of assets even though there is no presumption of splitting of assets in a Pennsylvania divorce case. When they bought the house, like most people, they took out a 30-year mortgage for $270,000. In 2015, with homes in the neighborhood selling for $490,000, they decided to take advantage of lower rates and refinance a fifteen-year mortgage. The new refinancing debt was then $215,000.

Today, as we all know, home values ​​have “exploded” and market studies indicate the home is worth $60,000 more. Part of the reason for the “pop” is that rates have come down a lot. Our couple reportedly refinanced at around 3.77% in 2015. By July 2020, rates had fallen to 3%. They bottomed out in January 2021 at 2.74%. They recovered slightly towards the end of 2021, ending in December at 3.1%.

Friday’s Wall Street Journal (4/1) reports that “mortgage rates jump to highest since 2018.” The article reports that mortgage bankers say they see no letup in applications. Realtors report that in most markets inventory is painfully thin. But Freddie Mac reported on Thursday that the average rate on the conventional 30-year fixed mortgage was 4.67%. So what was 3.1% in December is now 4.67%. It’s inflation. In December, gasoline was $3.40. Today I see $4.29. If gas prices matched mortgage rates, a gallon would cost $5.10.

Now back to our couple in their now $550,000 home. The mortgage is around $130,000. Most Pennsylvania counties levy 7% of fair market value to account for a 6% sales commission and 1% transfer tax. On $550,000, that’s a $38,000 adjustment. Subtract that with the balance of $130,000 and the “equity” in the home is $382,000. If one party buys out the other 50/50, the buying party will assume the mortgage balance of $130,000 and pay the other party half of the equity of $382,000. This gain is $191,000.

In our case, it is clear that there are only two options. Only one of the parties has the income to assume the mortgage of $130,000 and the $191,000 necessary to repay the other spouse. Four months ago, we would have told that spouse to refinance the whole house for 15 or 30 years and get a new mortgage at 3.1% for $321,000. Now, just ninety days later, it makes no sense to pay off a 3.77% mortgage and turn that $130,000 into a 4.67% mortgage. We therefore advise the client to keep the old mortgage and add an equity of $191,000 to buy out his spouse’s interest.

Now let’s look at this in terms that we all understand. What is the monthly “nut”? Ultimately, we buy homes based on affordability and the hope/expectation of appreciation over time. If our client had made the transaction in December, he would have borrowed $321,000 over 30 years at 3.1%. His mortgage and interest payments were reportedly $1,371 per month. Today, his best option is to keep his mortgage at 3.77% for 15 years at $1,565 per month and add the $191,000 in the form of a home equity loan. This loan at today’s rates will be $987 per month for thirty years. For the next eight years, he will pay $2,552 per month. His redemption will occur when the 15th year is paid in 2030 and he will have $987 per month left for 22 more years.

There is a child and no doubt the couple would like to help this child with college. But during those golden college years, the mortgage was $1,000 a month higher than it is today. Could have been $194 cheaper if we could come back in late 2021.

There are other risks to discuss. House price deflation. We already had it. At the end of the 1990s and in 2009-2010 during the great deflation. The houses were not moving and the bottom feeders were offering low bids. There is also another force at work. In our case, the house is on a 4 acre lot. It’s 3,500 square feet. When it was built in 1998, it was the quintessential high-end home. But 4 hectares? And while 3,500 square feet remains popular, the trend seems to be heading down for the first time in terms of the space people want. Last, but not least, there is what can be called “buyer affordability”. Let’s say a year from now, the 30-year mortgages are 5.5% and our client either transfers or otherwise needs to sell (to contribute to college, for example). If he puts the property at $550,000 and his buyer does 30-year financing of 95% at 5.5%, this buyer will pay $3,000 per month + $700 in property taxes. So add property and casualty insurance, and the potential buyer will receive a coupon that says to pay almost $4,000 a month for housing. Next, mow your 4-acre garden. The thing is, our client missed a chance to buy out the spouse and keep the housing costs with taxes and insurance close to $2,000. The person he sells to will have to pay double that amount. This buyer may say that he will not go above $500,000 because he cannot afford this monthly payment and the customer will have to bear a loss of $50,000.

It’s emotional. Yes, it would be nice to keep the children in the house where they grew up. But the joy of that same room is tempered by the sad face of a parent who can’t really afford or lose money to keep that room. As one former client who moved more than a dozen times during her childhood said; “It’s never easy to move, but you get used to it.”

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