When I sit down with clients who are considering a divorce (or already have the ball rolling) I have learned that deciding what to do with the family home has far more to do with emotion than it does with practical financial planning.
Allowing your emotions to drive your decision regarding the family home may lead you to make a poor one. Staying in the home for fear of disrupting the kids’ routine could actually cause far more disruption than starting over in a home you can afford. Before you decide if you should stay or go, you need to ask yourself these questions:
- Why do I even want to stay?
- Is this home going to drain all of my cash?
- Can I afford the payments on my own?
- Am I forgetting about a potential tax liability?
- Can I even qualify for a refinance by myself?
1. Why do I even want to stay?
Are you staying only because you are worried about further upheaval in your kids’ lives? Is it because you think moving is going to create even more trauma? Is there a part of you that thinks keeping your kids (and yourself) in the same environment will somehow make this enormous life-shift less monumental?
The truth is, you have to get really honest with yourself about the reasons you want to keep the house. No single reason is necessarily right or wrong. Some reasons are financial. Some are very intensely personal. Regardless of why you may want to stay in your home, if you are going broke to do so, you will wind up creating a far more stressful environment for your family than if you had just decided to move on to something more affordable.
If your kids’ feelings are your primary motivation, then make them a part of this decision. Explain to them your new financial reality and why it may be best to find a new home where new memories can be created. Ask them what is most important to them. You might find that what they are really seeking is the comfort of the peace that is created within the four walls, and not necessarily the structure itself.
2. Home sweet home, or just a big money pit?
In case you haven’t seen the movie that I am referring to, it was a rather popular tale from the 1980s of a hapless couple (portrayed by a very young Tom Hanks and Shelley Long) pouring good money after bad into a home that is falling apart. Hopefully you didn’t encounter the same problems that Walter and Anna did after you initially moved in, but the current family home could nonetheless wind up becoming a modern-day money pit of a different variety.
If keeping the family home means giving up all other liquid assets to your spouse, you could be signing up for a hefty monthly mortgage obligation with no real cash to make the payments. I’ve seen this one time and time again, especially in my home state of California where housing prices are sky-high.
These days, our homes tend to comprise the majority of our net-worth, so it’s possible that keeping the home may require you to pay out your soon-to-be-ex for their portion of the equity through a cash-out refinance. This option creates an even larger debt on the property than you and your spouse carried together when you were married – that’s a huge deal. Making a bigger mortgage payment with less income is likely not feasible and might not allow you to comfortably provide the same lifestyle you and your children enjoyed pre-split. Talk about a serious Money Pit!
3. Can I even afford a house payment post-divorce?
There are several factors to consider in determining your ability to maintain the family home after your spouse has set up household elsewhere and you are now on your own. You are essentially running the same household on a fraction of the former family budget, and this can be a very difficult balancing act.
“Going from two incomes to one is really hard,” says Lauren Forbes, Founding Member of the Forbes Group in Manhattan Beach, CA. Lauren has been dominating the real estate market in California’s South Bay for nearly 20 years and understands the pitfalls that divorcing couples face as they transition from one home to two. “Staying in the same school district is important for many of my clients who are in the market for a new home post-divorce, and it can be challenging finding something that checks all those boxes.”
Be realistic and know your expenses. If you haven’t sat down with a pen and paper and drafted your new post-separation budget, you must do so before making any decisions regarding the home. This is also a great time to engage a financial advisor, who can work with you to sort through your new financial reality and help you make these decisions objectively, and not emotionally.
4. Am I signing up for a huge tax liability?
I was introduced to one of my clients about four years after a particularly painful divorce from her husband. She had been hellbent on keeping the home that she and her husband bought when their children were very young. It was a beautiful home in a beach community of Los Angeles that was purchased for $3,300,000 (complete with a $2,200,000 mortgage). At the time of the separation, the home was worth about $5,500,000, and the mortgage was paid down to about $2,000,000.
After reviewing her financial situation, she heeded my (gentle, albeit firm) advice to sell and move to something smaller. The finalization of the divorce years prior had left her with about $1,000,000 in cash, a beautiful beach home and an enormous monthly mortgage and tax bill.
Two years after giving her ex-husband a majority of their liquid assets in exchange for the home, she finally came around and realized that the house was creating far more insecurity than stability for her and the kids and it was time to let go. After paying close to $400,000 in commissions and closing costs, she realized a profit of about $3,100,000 of which she owed nearly $1,000,000 in tax. This asset that was valued at $3,500,000 on her side of the balance sheet during the divorce negotiation only yielded her about $2,100,000 when all was said and done. So what went wrong here?
This is one of those hidden “disasters in disguise” that may take an expert’s knowledge to help you side-step. As couples are slicing up their estate and moving assets on either side of the newly created “Mine and Yours” balance sheet, they (and often their attorneys) forget about the mechanics of the capital gains exemption of the home.
If you and your spouse sell the home during the divorce, you are able to take a $500,000 combined capital gains tax exemption on the sale profits. If you take the home on your own and decide to sell it down the road, you will only be able to utilize the single exemption of $250,000. This could mean tens of thousands of extra dollars going to taxes when you are ready to move on, not to mention that you will solely bear the cost of the transaction (closing costs, brokerage commissions, etc). Selling the house now and splitting the profits (and any associated costs!) with your soon-to-be ex may be the smartest financial move in the long run.
Had my client been counseled to sell the house with her ex-husband before the ink was dry on the divorce decree, they would have had a combined exemption of $500,000 (as the house was their joint primary residence) and they would have shared in the cost of the selling fees. My client’s half of the savings would have amounted to nearly $300,000.
5. Can I even refinance on my own?
Qualifying for a mortgage on your own without your spouse’s income can be challenging, especially if you are the lesser-earning spouse or significantly dependent on child support or alimony for your living expenses. Banks typically like to see at least 6 months of support payments coming in before they will qualify that income toward your debt-to-income ratio calculation, and they will usually require that support payments are scheduled to continue for 3 years after the loan closes. This could mean that you would need to wait 6 months until after your divorce is finalized before you begin seeking the refinance. For various reasons, credit scores can also be negatively impacted during and after divorce proceedings, making it more difficult to refinance.
Interest rates have increased significantly in 2022, so the cost to finance has gone up considerably. Just last year a 30-year fixed mortgage was around 3%. If your intention is to stay in your current home and your stipulation dictates that you must refinance the home into your name (removing your ex from the mortgage) the cost to remain in the home will undoubtedly be much higher than it was before.
Are there good reasons for you to stay in your home post-divorce? Maybe. Are there a lot of things you need to take pause and consider before deciding? Absolutely. Take your time and utilize all the resources available to you: your lawyer, accountant, financial planner, and real estate agent who is knowledgeable in these matters. Make sure that you are making the best choice for you, your family, and your future.