(July 13, 2024)
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Divorce can be a challenging and emotional journey, and the financial implications often add an additional layer of complexity. One of the most significant financial decisions is determining how to fairly divide shared assets, particularly the matrimonial home. For many, the solution involves paying out a spouse through a mortgage refinance. This process, while seemingly straightforward, requires careful consideration and understanding of both legal and financial nuances. In this article, we will explore the key steps involved in refinancing a mortgage to ensure a settlement, providing you with the knowledge needed to navigate this critical aspect of divorce with confidence and clarity.
The (4) Steps to Funding a Divorce Settlement with Mortgage Proceeds
(1) Get preQualified for a mortgage
Before even considering buying out your spouse, connect with a mortgage broker to see if your qualification prospects are attainable. Keep in mind that buying out your spouse requires not only using mortgage proceeds for the buyout but also removing them from the mortgage, thereby placing the entire qualification burden on yourself. Connect with a mortgage broker for a short pre-qualification assessment to ensure you qualify for the amount you are seeking.
(2) Do I need a separation agreement?
Now that you are certain you can qualify for the mortgage, you can proceed with the mediation process of your separation. This part of the process often drags on and causes the most delay. A formal separation agreement is needed only if there are spousal or child support payments involved. Otherwise, you can proceed without a separation agreement by simply declaring that there is no spousal or child support. This way, spousal buyouts can proceed without having to wait for formal separation agreements to be drafted.
(3) Determine the Value of the Home
This can be achieved in various ways: appraisal, realtor opinion, or a mutually agreed-upon figure between the separating spouses. A mortgage refinance can also serve as a built-in home valuation since appraisals are required when refinancing a home (the appraisal will determine the fair market value of the property). Appraisers are restricted from communicating with the mortgage originator (mortgage broker) and the homeowner during the process. This is a strict safeguard implemented by the lender to prevent homeowners and mortgage originators from pressuring or influencing appraisers. Appraisal values are typically accurate as they reference comparable sales of properties within the vicinity of yours (at least three comparable properties are included in the formal appraisal report).
(4) Submit to the Lender for Approval
With a predetermined value of your home now set, you can proceed to present your application to a lender for refinancing. As this is a refinance to buy out, you can refinance the property up to 95% of the appraised value. However, keep in mind that the maximum 95% limit is not an automatic or default threshold for all applications. The true limit is determined after the lender completes its adjudication process. A buyout that exceeds 80% loan-to-value may require an additional step. Since mortgage refinance rules in Canada are restricted to 80% loan-to-value, any threshold above 80% is classified as a purchase mortgage (rather than a refinance mortgage). Therefore, to comply with lending guidelines, a purchase agreement is drafted between the separating spouses to validate the purchase transaction. The purchase agreement confirms the value of the property and further clarifies that the down payment is derived from the equity.
Other Factors to Be Aware Of:
- If there is an existing mortgage in place, you can expect a break penalty as you will be amending the existing terms of the current mortgage contract. Consult directly with your existing lender to find out what your break penalty will be. In most circumstances, the penalty is worked into your new refinanced mortgage, thereby sidestepping any out-of-pocket expense.
- If you exceed 80% loan-to-value on your mortgage, you will incur a standard insurance fee on your mortgage principal. Similar to a mortgage break penalty, the insurance premium is blended into your new mortgage principal. For example, if your home is appraised at $600,000 and you have an existing mortgage of $400,000 but require an additional $125,000 for the buyout, this equates to a loan-to-value ratio of 87.5%. As mortgage insurance premiums are tiered, at 87.5%, your premium would be 3.10%. Your new mortgage would amount to $541,275 ($525,000 calculated mortgage principal plus $16,275 insurance premium).
- If your income is not sufficient to qualify for the mortgage you require, you can add a co-signer to your application.
- To decrease your mortgage payments, you can amortize your mortgage up to 30 years (for loan-to-values less than 80%). For loan-to-values of 80% or higher, the amortization is capped at 25 years.
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