If you own a house as a couple and get divorced, one party must buy out the other unless you sell the home. Typically, one spouse must refinance the mortgage in order to buy the other out unless he or she has the cash available to pay the spouse out.
The two most common ways to buy a spouse out are with a cash-out refinance or home equity line of credit. Both offer access to your home’s equity, just in different ways.
The Cash-Out Refinance
A cash-out refinance is a refinance of your first mortgage. You take out the amount needed to pay off your existing loan plus any amount you need to pay off your ex-spouse. Most cash-out refinance loan programs today allow you to take out up to 80% of the home’s value in a cash-out refinance.
Each loan program has a cash-out refinance program. In general, you need:
- Stable income and employment
- Enough income to cover your debts plus the new mortgage while maintaining a debt-to-income ratio of less than 43%
- Proof of your income via paystubs, W-2s, and tax returns
- Proof of timely mortgage payments on your first mortgage
- Proof of the home’s value and that you won’t borrow more than 80% of the home’s value
Since you will borrow more than the current mortgage balance, expect to pay a slightly higher interest rate to make up for the risk.
The cash-out refinance provides the funds for your ex-spouse in one lump sum. You immediately start making interest and principal payments, just like you do on your current first mortgage. You don’t have access to the equity after the initial disbursement.
The HELOC or home equity line of credit is a second mortgage. You don’t need to refinance your first mortgage if you take out a HELOC. Many people choose the HELOC if they don’t want to touch their first mortgage. If you have a good interest rate on your first mortgage, it’s best to leave it alone.
The HELOC is a second lien on the property. You can sometimes borrow more money with the home equity line of credit because it has fewer restrictions. Many lenders allow up to an 85% LTV, giving you a little more leeway.
The HELOC often has more flexible underwriting requirements too. You still need to prove that you can afford the loan and have adequate proof of your income, employment, and mortgage payment history. You must also prove your home’s value and that there’s enough equity in the home to take out in order to pay off your spouse.
The HELOC works a little differently than the cash-out refinance though. Rather than receiving all of the funds in one lump sum, you get access to a line of credit. You can use the funds as needed. If you have to pay one lump sum to your ex-spouse – you can do that. You then pay interest on the amount withdrawn for the next 10 years.
You can choose to make interest only payments for that 10-year draw period or you can pay the principal back each month. You can reuse the funds in the line of credit over the 10-year period if you want. Any money you don’t withdraw from the line of credit doesn’t require a payment.
After the 10-year draw period, you start making principal and interest payments on all amounts that you withdrew. You make these payments for the next 20 years until you pay off the loan.
Which Option is Better?
The cash-out refinance and home equity line of credit both offer plausible solutions to buy out your ex-spouse. Which one is right for you depend on certain factors:
- Do you have a good interest rate on your first mortgage now?
If so, you may want to check out a HELOC to avoid messing with your interest rate.
- Do you have the ability to make principal and interest payments right off the bat?
If you need lower payments, you may want to stick with the HELOC and enjoy the interest-only payments for the first 10 years
- Will you borrow less than 80% of the home’s value?
The cash-out refinance won’t go any higher than 80% of the home’s value. If you need more than that, the HELOC is a better choice.
- Do you have need for future access to your equity?
If this isn’t a one-time need for funds, the HELOC provides revolving access to your funds as you pay the principal back.
Shop around to find the best deal for you to tap into your home’s equity. Paying off an ex-spouse means that you must qualify for a loan on your own. If you had a joint mortgage before, you may have to do a little work before you can qualify for the loan. Find the loan with the best interest rate and terms to make the process of buying out your spouse’s equity as painless as possible.