Thank you to John Trenton from Refinance Mortgage Rates for this guest post. Unfortunately, this is a situation our clients face from time to time. It is a good reminder that for homeowners facing divorce, there are many challenges but also options. Both your lender and your real estate agent can help you sort through those options.
Buying a home after a divorce presents special challenges, but with some attention to detail it is possible to overcome these situations and acquire the right home for the next phase of life.
Divorce can leave both spouses in difficult financial circumstances, but they each still need places to live. For many, that means buying a home. Often, however, divorced couples are left with a remaining mortgage on their joint home that neither of them knows how to effectively manage.
Home Mortgage Refinance for the Old Home
Before either party can consider a new home, it is important to deal with the mortgage on the former home. While selling the property and splitting any proceeds is often the most logical way to go, that is not always possible.
In cases where one partner wants to keep the home, it is essential for the other party to make sure his or her name is removed from all paperwork to limit liability and protect the individual's credit history in case of default by the other spouse.
A home mortgage refinance is often the best course of action if the joint home is not being sold. The party who wants to keep the home may not automatically qualify for refinancing, however. Proof of income and other paperwork is usually still required, and this can be difficult to provide after a division of assets.
Since the original lender is under no obligation to help with a home mortgage refinance, many find solutions from other lenders.
Considerations for the New Home
Financial experts recommend that newly divorced homebuyers get a letter of approval from a lender before going to see new homes to prove to real estate agents that they have adequate resources to make a purchase.
Before looking at any property, they should also carefully consider what size monthly payment is comfortable for them and how large a home they can reasonably afford in their new financial circumstances.
While it can be difficult to get a new home loan after divorce, some lenders approve clients for larger mortgages than they can handle. It is important for the recently divorced who are considering homeownership to take into consideration the costs involved in upgrading the new home as well as other difficult-to-predict costs that impact the monthly budget like transportation to and from the new neighborhood.
Couples with joint custody of children must consider their proximity to each other when choosing a home location and must make sure both homes have enough room for the children to stay over.
It is also important for divorced people to consider how their social lives will develop after a divorce. A suburban home can seem lonely to those living without a partner, but a downtown condo could be just the thing to spur a new lease on life.
While buying a home after a divorce can be challenging, it is also an important step toward normality for those whose lives have been in upheaval for months or years.
Did you ever wonder why banks seem to approve so few loan modifications and often just foreclose instead? For any home owner, that seems ludicrous. Any rational person would think, “Why can’t they just fix my adjustable rate mortgage at today’s rate and keep me in my home and paying my mortgage? Why would they want to risk having me stop making my payments and incur all those legal fees associated with a foreclosure? Aren’t there government programs that incentivize banks to work with home owners to modify loans?” But you are a rational person, not an insider at the bank. It’s whole different story if you know which rock to turn over.
The cold, hard truth is banks may make more money when they foreclose on a house than when they modify its loan. At this point, it becomes relevant to distinguish between a loan servicer and the investor that actually owns the debt. For example, Bank of America may collect the monthly payments but not own the actual loan. B of A is often only the servicer for an investor who coughed up the cash (or bought the mortgage backed security) for the actual loan amount. Loan servicers (B of A in this example) may make more money when the property forecloses. Being professional paper-pushers, they slap delinquent accounts with late fees, legal fees and other random “processing” fees. If the home forecloses, those back fees must be paid because the servicer is pretty high on the food chain of lien holders. If a loan is modified, often the servicer must waive those junk fees or roll them into the modification agreement. If the fees are rolled into the loan, the servicer gets paid back over the course of 30 years as the borrower pays off their mortgage. The servicer who is not only processing your monthly payments but also handling all your loan modification paperwork asks themselves: “Would I like all my money paid in full soon or potentially have to waive all my fees to process this modification?” To take it a step further, if the investor agrees to modify the loan from 6% to 5% interest rate, the servicer loses money over the long run too. These are the people processing the loan modification applications. No wonder they “lose” so much paperwork from well-intentioned borrowers.
To answer the question “Aren’t there government programs that incentivize banks to work with home owners to modify loans?”…well yes. The Home Affordable Program (HAMP), birthday March 2009, offers banks between $500 and $1500 to work out a loan modification with home owners. Let’s do the math. Thousands of dollars’ worth of junk fees waived + a reduced interest rate = let’s just say it’s more than $500 – $1500. I’m pretty sure servicers can do that math. (Source: HAMP Compensation Matrix, updated Nov 9, 2010).
Let’s consider the investor who is neatly tucked behind the servicer. The servicer is out in front taking all the heat from consumers and the press because they think that servicer actually owns the loans they process payments for. That investor isn’t stupid. They insured the loan on the property in the first place. (Think: AIG). When the house forecloses, it’s very likely the investor is paid in full by their handy insurance policy. That’s why we buy insurance, right? Then when that house goes up for sale on the courthouse steps, that investor (or sometimes the servicer) sends out their people to “buy it back”, so it becomes a “bank-owned property”. If there is no one else bidding on the home, they buy it back well under market value. Then they list the property as an REO / bank-owned property and sell it. As the owner/seller, they bank the profit. Then…this is the gross part…if the home owner refinanced that loan at any point, the investor can also sell the borrower’s “debt forgiveness” to debt buyers for pennies on the dollar. See: http://en.wikipedia.org/wiki/Recourse_debt They can sell the right to collect on that “shortfall” to some vultures for a couple thousand dollars that then have the right to pursue the unfortunate borrower until the day they die. I am not being dramatic here. There is literally no statute of limitations on how long the debt buyer (aka collection agency) has to pursue that borrower. The debt buyer who paid $1000 for the loan then has a tremendous opportunity to make a killing trying to collect as much as they can wring out of the borrower. The grand finale: the investor reports the re-financed loan’s shortfall to the IRS as income to the borrower. Let’s do the math. Insurance pay-out + profit from selling the house as a bank owned property + a little cash on the back end to peddle it to a debt buyer = let’s just say it’s more than $500 to $1500. I’m pretty sure the investors, like their buddies on the servicing end, can do that math.
The media rages: “Why isn’t the HAMP program helping more people stay in their homes? It’s an utter failure! It doesn’t make sense!” Right, it doesn’t make sense to the banks either. Can you imagine what the government would have to pony up to compete with the profitability equation the banks enjoy when they foreclose on a house? If people thought the TARP bailout was over the top, it would pale in comparison.
Just a few ideas about why the banks (servicers and investors) might choose to foreclose on a home rather than modify the loan. My guess is this is just the tip of the iceberg.
As a Realtor®, I find myself having some pretty quirky conversations about credit scores with my clients. I get to tell stories that sound like old wives’ tales and recipes. For example: “I had some clients who were so excited about buying their first home, they went running out and bought a whole new bedroom set. They fell into the ‘No Interest for 3 Years!!!’ trap and financed their new ‘free’ furniture. They almost lost that new home over coveting a new bed.” What? Yep, your lender pulls your credit again just before they ship out the piles of loan documents for you to sign. They want to see if anyone went out and bought a new car, stopped paying their credit cards or…bought a bed.
As you can see from the lovely pie chart depicted above, there are 5 ingredients mashed up into your FICO score dessert. Take, for example, the bedtime story. When my eager young buyers went to Store Credit A-Go-Go (not the real vendor’s name, the real vendor is – uh – bankrupt), they took advantage of the in-store credit option. That carves up that “15% Length of Credit History” piece and mixes it in with the “10% New Credit” ingredients of the pie. 25% of their credit score was hanging in the balance. Since they were only a few points above the threshold required for their loan qualifications, they dropped just enough to fall out of eligibility for their loan program. No dollop of whipped cream on that serving. Their lender barely had time to switch them into a different loan program so they didn’t lose their first home. They ended up paying a higher interest rate because they were deemed higher risk borrowers.
Or my funky ditty about my buyer’s new computer… “I had this buyer once who saw an ad for the biggest, baddest computer known to mankind with monthly payments of only $24 per month (on approved – wait for it – credit)”. Unlike the first scenario, she had a FICO score with plenty of room to move. Instead, she served up a heaping slice of “30% The Amounts You Owe”. When her lender pulled her credit a few days before closing, her total amount owed hopped right out of the mixing bowl into a splat on the floor. You see, boys and girls, even if you only pay $24 a month for your fancy abacus, your score says you owe the whole $3000 now. With her house on the line, she coughed up the $3000 to bring her debt ratio back into the acceptable range required by her loan’s underwriting standards.
Then there’s the new refrigerator another buyer decided she wanted to get from Lowe’s because she could get 10% off if she put it on her new, shiny Lowe’s card. That is a cholesterol- busting combo of “10% New Credit” + “10% Types of Credit” + “30% The Amounts You Owe” + “15% Length of Credit History”. Ouch.
I am chock-full of Betty Crocker greatest hits of close-call credit nightmares. Too bad I get to be the wet blanket all over my buyers’ consumer aspirations while in escrow. “Don’t buy anything. Don’t close any credit card accounts. Don’t move a muscle.”
Fair Isaac Corporation (FICO) launched a consumer education website. (www.scoreinfo.org) They came up with that fancy pie chart showing the breakdown of the factors under consideration when reporting agencies whip up your credit scores. This is not your mama’s apple pie. You should check out the recipe.