When going through a divorce and one spouse wishes to buy out the marital equity of a jointly owned property, there are typically two primary mortgage financing options: a limited cash-out refinance and a cash-out refinance. Each has its own advantages and considerations, and the choice between them depends on your specific circumstances. Here’s an explanation of both options:
1. Limited Cash-Out Refinance:
A limited cash-out refinance is a mortgage refinancing option where the new loan amount is limited to paying off the existing mortgage balance and covering some settlement costs and the buyout. This type of refinance is often used in the context of divorce to facilitate a buyout without taking out additional funds. Limited cash out refinances have a maximum loan to value of 95%, meaning you can borrow up to 95% of the appraised value of the home, if needed to facilitate the buyout. A Limited cash out refinance will generally have a lower interest rate than a cash-out refinance because in a limited cash out refinance, you are not taking out additional cash, limiting the risk to the lender.
Here’s how it works:
a. Determine the Property’s Value: First, you’ll need to get a current appraisal of the property to determine its fair market value. This is crucial for calculating the buyout amount.
b. Negotiate the Buyout: You and your spouse should agree on the buyout terms. This includes determining the amount the departing spouse is entitled to receive, considering factors like the property’s current value, any outstanding mortgage balance, and any other financial considerations like home equity loans/lines of credit and property taxes.
c. Apply for a Limited Cash-Out Refinance: The spouse who wishes to keep the property applies for a limited cash-out refinance with a mortgage lender. The new mortgage amount should cover the existing mortgage balance, the buyout amount, and any refinancing costs. The borrower cannot receive any proceeds from the refinance, not even a penny, or else it is considered a cash out refinance. Tip, to avoid this happening, make your new loan amount a few hundred dollars less than what you will ultimately need, yes you will have to come to close with some money, but that is a lot better than taking the cash-out refinance rate, I promise you.
d. Closing and Transfer: Once the limited cash-out refinance is approved, the departing spouse will receive their agreed-upon share of the equity in the form of a check or wire transfer from the title company. To receive said funds, the title company will require the departing spouse to sign a deed, removing themselves from title, which will be recorded at the county and become official record. This removes them from the mortgage and property ownership.
Pros of Limited Cash-Out Refinance:
• Generally simpler and quicker than a full cash-out refinance.
• Can be more cost-effective, interest rate-wise since it doesn’t involve taking out additional funds.
• Allows access to more equity, if needed.
Cons of Limited Cash-Out Refinance:
• Limited to the amount needed for the buyout and closing costs.
• No additional cash out allowed.
2. Cash-Out Refinance:
A cash-out refinance allows you to refinance the mortgage for an amount greater than the existing mortgage balance, with the difference being given to you in cash. This option provides more flexibility in terms of accessing cash but can be more complex and costly. Cash out refinances have a maximum loan to value of 80%, meaning you can borrow up to 80% of the appraised value of the home. Cash out refinances have higher interest rates than limited because in a cash out refinance you are taking additional equity, increasing the risk to the lender.
Here’s how it works:
a. Determine the Property’s Value: Like with a limited cash-out refinance, start with a current appraisal of the property to establish its fair market value.
b. Negotiate the Buyout: Agree with your spouse on the buyout terms, taking into account the property’s value, mortgage balance, and any other financial considerations like the ones mentioned above.
c. Apply for a Cash-Out Refinance: Apply for a cash-out refinance with a mortgage lender. The new loan amount will include the existing mortgage balance, the buyout amount, and any additional cash you want to receive.
d. Closing and Transfer: Once approved, the departing spouse receives their share of the equity in cash, and their name is removed from the property title and mortgage in the same manner as with the limited cash out refinance and the borrower receive the cash they requested.
Pros of Cash-Out Refinance:
• Allows for access to more cash, above and beyond the buyout, if needed.
• Can help pay off other debts to provide better monthly cash-flow post-divorce.
Cons of Cash-Out Refinance:
• Typically involves higher interest rates.
• The new loan amount is limited to 80% of the appraised value of the home.
• Increases the overall mortgage debt, potentially leading to higher monthly payments.
In both cases, it’s essential to work closely with legal and financial professionals who specialize in divorce-related real estate transactions to ensure that the process is fair and legally compliant. Additionally, consult with a CDLP to explore your financing options and determine which approach aligns best with your financial goals and circumstances.