Divorces typically involve splitting marital assets, including built-up equity in the family home. A cash-out refinance could allow one partner to remain in the residence and buy out the ex-spouse’s share of equity.
We’ll cover the main points you need to know about using a cash-out refinance for a divorce buyout, including the pros and cons and some alternatives you may want to consider.
Key Takeaways
- A cash-out refinance allows one spouse to use a home’s equity to finance a divorce buyout.
- You may be eligible for a “divorce buyout” refinance, which comes with better terms than a traditional cash-out refi.
- The spouse remaining in the home must be able to meet lender requirements for the new mortgage.
- In some cases, an equity buyout refinance can be used to qualify for a larger loan and lower interest rate.
How Does a Cash-Out Refinance Work in a Divorce Buyout?
A cash-out refinance involves taking out a new loan larger than your current mortgage, with the difference issued as a lump sum after closing. When used as part of a divorce buyout, one partner can refinance a property into their name alone while cashing out funds to pay off the other’s share of the equity.
For Example: A married couple filing for divorce has a $150,000 mortgage on a home valued at $400,000. In this scenario, they share $250,000 in built-up equity, equating to $125,000 per spouse if evenly split. The partner planning to remain in the home would do a cash-out refinance for $275,000, paying off the $150,000 mortgage and compensating the departing partner for their $125,000 equity share.
In most cases, cash-out refinances require you to retain at least 20% equity in the property after taking out the funds you need. As such, using a standard cash-out refinance for a divorce buyout is most practical for homeowners with at least 40% equity.
However, borrowers refinancing to buy out their ex-spouse’s share of the home may have a unique option, an equity buyout refinance, which we’ll cover a little further down.
The Process
Using a cash-out refinance for a divorce buyout involves working with a lender and going through their complete underwriting process. You should plan for the refi to take four to six weeks, although the timeline may vary based on your chosen mortgage provider.
Here’s what you can expect from start to finish when dividing up equity with a cash-out refinance.
Determine the Equity in the Home
Your equity is the difference between your home’s value and any mortgages or liens.
While many online platforms can give you a rough estimate of your home’s value, a professional appraisal is the best way to get an accurate measure. Prices vary by area and appraiser, although most homeowners can expect to pay between $350 and $600, according to HomeGuide.
“An accurate appraisal is critical to determine the fair market value and ensure a fair buyout amount,” says William London, family law attorney and partner at Kimura London & White LLP.
Keep in mind that you will need to have an appraisal completed as part of your cash-out refinance, and you cannot use a previously obtained appraisal report to avoid this requirement.
Agree on a Buyout Amount
Once you know how much equity you have in your home, the next step is to agree on the portion each spouse is entitled to. In many divorces, this involves splitting the total right down the middle. However, an equal division is not always the case.
Before deciding on a buyout amount, it’s wise to seek legal and financial guidance from professionals familiar with divorce settlements and applicable laws in your state.
Apply for a Refinance
Applying for a cash-out refinance is much like the process you encountered taking out your initial home loan. It will involve undergoing a detailed credit check, providing proof of income and assets, and having the property professionally appraised.
The spouse remaining in the home will need to qualify for the mortgage per the lender’s credit and income requirements. This can sometimes pose a challenge for applicants who had previously qualified based on a dual income, especially when cashing out equity and increasing the overall loan balance.
Cash-Out Refinance
A standard cash-out refinance will typically allow you to tap into as much as 80% of your home’s value. Using the figures in our previous example, a $400,000 home could be eligible for a cash-out refinance of up to $320,000, which would be adequate to cover the existing mortgage and equity buyout in that sample scenario.
In addition to sufficient equity, you will need to meet your loan type’s and lender’s credit score minimum. Conventional guidelines require a credit score of at least 620 for a cash-out refinance, but many lenders set higher minimums. Refi.com requires a 660 credit score for a conventional cash-out refinance.
You’ll also need to meet the lender’s debt-to-income limits, which commonly require your total monthly debt – including your refinanced mortgage – to make up no more than 43% to 50% of your qualifying income.
Equity Buyout Refinance
Conventional loan rule-maker Fannie Mae maintains special guidelines allowing borrowers to refinance to buy out the interest of a co-owner, including in divorce situations.
This special “divorce buyout refinance” allows the borrower to take cash at closing for the sole purpose of an equity buyout, while still enjoying no-cash refi guidelines. Rules are as follows.
- Both parties must have jointly owned the home for at least 12 months.
- The parties sign an agreement stating how much the departing party will receive
- The remaining party qualifies for the new loan on their own
- The remaining partner does not receive any cash proceeds from the transaction.
This unique type of cash-out is referred to as an equity buyout refinance and has the benefit of:
- Allowing for a higher loan-to-value ratio of up to 95-97%
- Lower interest rates than a standard cash-out refinance
Note: Borrowers applying for an FHA-backed refinance may also be able to qualify under the agency’s rate-and-term program as FHA guidelines consider a divorce buyout to be “property-related indebtedness.” This makes it eligible to be included in the loan without completing a full cash-out refi.
Close on the Refinance and Disburse Funds
Once the underwriting process has been completed, your lender will set the date for closing. This is when all the paperwork will be signed, the cash-out refinance will be made official, and ownership of the property will be transferred.
As mentioned, this typically takes four to six weeks after submitting a loan application, although your results may vary. Since federal law allows for a three-day waiting period on refinances, you can plan to see the funds disbursed to the leaving partner in three to five days after closing.
Benefits of Using a Cash-Out Refinance for a Divorce Buyout
While a cash-out refinance is not the only way to divvy up equity in a family home as part of a separation agreement, it’s often the most straightforward option. Here are some of the primary benefits of using one for your divorce buyout:
- Refinancing allows one partner to remain in the home, minimizing disruption to their lifestyle and children.
- A refi makes the remaining spouse the sole holder for the property and mortgage, allowing the leaving partner to search for new housing without having to qualify with two mortgage payments.
- Interest rates and terms are better with a cash-out refinance – and especially with an equity buyout refinance – than with other lending alternatives such as a home equity loan or HELOC.
Potential Challenges and Risks
Before committing to a cash-out refinance for your divorce buyout, however, be sure to consider the potential challenges and risks. Some of the most prominent include:
- The spouse remaining in the home will need to qualify for the new mortgage based on a single income.
- Monthly mortgage payments may increase based on the larger loan balance, particularly when compounded with a higher interest rate.
- If housing expenses become unaffordable, the remaining spouse risks being forced to sell or losing the home to foreclosure.
- Refinancing involves paying closing costs, often 2% to 4% on conventional loans, which can reduce the funds available to cash out.
Cash-Out Refinance Options
Here are the most common options that lenders offer:
- Conventional Cash-Out: Conventional mortgages are the most widely available type of home loan and allow you to borrow up to 80% of your property’s value in a cash-out refinance. Expect to need a credit score of 620+ and a debt-to-income ratio below 50%. Refi.com requires a 660 FICO credit score for a conventional cash-out refinance.
- FHA Cash-Out: FHA cash-out refinances are insured by the Federal Housing Administration and can be easier to qualify for. According to HUD guidelines, they allow credit scores as low as 500 and debt ratios up to 56.9%. Keep in mind that most lenders, like Refi.com, often have stricter requirements. Refi.com requires a 620 credit score for an FHA cash-out refinance. This cash-out option also enables a loan-to-value of up to 80%.
- VA Cash-Out: VA cash-out refinances are backed by the Department of Veterans Affairs and available to qualifying veterans and active-duty service members. Many VA lenders will let you cash out up to 90% of your home’s value, while some may allow a full 100% refinance. Credit score and debt requirements will vary by mortgage provider.
- Jumbo/Non-Conforming Cash-Out: Jumbo cash-outs refer to refinances larger than the maximum conforming loan limit. Jumbo refinances often have stricter requirements and higher interest rates than conventional or government-backed alternatives.
How Do Lenders Address Alimony and Child Support Payments?
Since separation agreements frequently involve alimony and child support payments, we’ll briefly discuss how conventional lenders address them during the mortgage qualification process.
Note: Different types of loans may have different rules regarding alimony and child support payments. We’ll focus on conventional guidelines as they apply to most cash-out refinance transactions.
Refinancing Spouse Is Receiving Payments
Income from child support and alimony payments can be counted as part of your income when:
- Payments will continue for at least three years
- You can document receipt of at least six months of payments
- Payments made over the past six months have been full, not partial, and consistent
If you’re doing a cash-out refinance for a divorce buyout as part of or soon after your divorce proceedings, it’s unlikely lenders will be able to count these payments as qualifying income for your new mortgage, due to the six-month receipt requirement.
Refinancing Spouse Is Making Payments
If you’re responsible for making child support or alimony payments and are applying for a cash-out refinance, lenders will typically consider them an ongoing debt obligation. The exceptions are when:
- You have ten months or fewer of payments remaining, or
- Payments are being made voluntarily and not as part of a court order or legally binding separation agreement
In some scenarios, lenders may reduce your qualifying income by the amount of your required alimony payments rather than classify them as a debt obligation. However, this decision depends on the individual policies of the mortgage company you’re working with.
Alternatives to a Cash-Out Refinance
A cash-out refinance is not the only option for splitting your home’s built-up equity in a divorce. Let’s cover a few alternatives that may be more practical for some homeowners.
Home Equity Loan or HELOC
Home equity loans and home equity lines of credit (HELOCs) are types of second mortgages that stack on top of your existing loan. This allows you to borrow against your equity without refinancing, which may be beneficial if you’re currently locked into a favorable interest rate. Closing costs are also generally lower than with a full cash-out refinance.
Keep in mind, however, that while a home equity loan or HELOC may provide the funds you need for a divorce buyout, they will not remove the departing spouse’s name from the primary mortgage.
Release of Liability
In rare cases, your lender may be willing to issue a release of liability, typically done by modifying the loan agreement, without you needing to refinance your loan. This would not provide any funds for an equity buyout but would serve to remove the departing spouse from the mortgage.
Assumption of Mortgage
Mortgage assumption is the process of taking over an existing loan with the same terms and interest rates currently in place. You’ll have to undergo the qualification process, and most lenders will charge an assumption fee. However, it’s likely to be far less than refinance closing costs.
This option will not provide funds for a divorce buyout, and conventional loans are not assumable. Government-backed mortgages insured by the FHA, VA, and USDA generally are, but not all lenders will be willing to approve an assumption.
Selling the Home
If neither spouse wants – or has the financial capability – to remain in the home, the most straightforward solution may be to sell the property, pay off the existing mortgage, and divide the proceeds as agreed.
Keep in mind that this could have tax implications in some situations, so make sure to consult a financial professional to find out how selling your family home as part of a divorce could affect you.
Dividing Other Assets
Since doing a cash-out refinance for a divorce buyout can often increase mortgage payments – especially when refinancing to a higher interest rate – some separating spouses choose to divide other assets in a manner that covers the amount due from built-up home equity.
For example, the partner remaining in the home may buy out the departing spouse’s share of equity with funds they’re due from other marital assets such as investment and retirement accounts.
How to Get Started
It’s wise to obtain professional advice before agreeing to any separation agreement. However, if you’ve already worked out the details of your divorce settlement and feel like a cash-out refinance is the best option for buying out your partner’s equity in your home, start your application with Refi.com today.
Related Reading:
Mortgage Assumption vs. Refinance in a Divorce
I’m Getting the House in My Divorce. Do I Have to Refinance the Mortgage?
Removing a Borrower with an FHA Streamline Refinance
