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If you are in the middle of a divorce and are looking to do a cash-out refinance on your home—hold on.
Before you make that move, let's talk about an equity buyout divorce mortgage that could save you a significant amount of money if you need to pay out your ex-spouse's equity in the home.
What’s more, the government-backed Fannie Mae recently announced a policy change that could make equity buyouts an even more attractive choice for mortgage holders who are negotiating a divorce.
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New rules from Fannie Mae
According to Fannie Mae, you have the option to classify your refinance as rate/term instead of a cash-out when purchasing your ex-spouse's ownership interest.
This distinction is significant because cash-out refinances tend to be more costly, with rates typically 0.25-0.50% higher compared to rate/term or limited cash-out refinances.
By selecting the appropriate classification, you can make a difference in terms of your own expenses and financial considerations.
Key points on an equity buyout mortgage according to Fannie Mae
Let's dive right in and explore a smarter financial path than a cash-out refinance for divorce—one that could save you money and give you the fresh start you deserve.
Rules to qualify for an equity buyout mortgage
To qualify for a rate/term refinance, you must meet certain conditions.
- The property was jointly owned for the previous 12 months
- Both parties sign an agreement regarding terms and use of the proceeds
- Provide a divorce decree specifying the buyout
- The remaining spouse can’t receive any funds from the refinance
These measures ensure clarity and proper handling of the refinancing process.
More detail on requirements
The divorce decree should clearly specify that one party will purchase the other party's interest in the jointly owned property.
You must provide documentation that demonstrates the joint ownership of the security property for at least 12 months prior to the disbursement date of the new mortgage loan. The only exception to this rule is in the case of an inheritance.
Consult with a legal professional to ensure all necessary legal requirements are met and to safeguard your interests throughout the process.
Only 3-5% needed for an equity buyout mortgage
To qualify for an equity buyout borrowers can have as little as 3% equity left in the home after the refinance according to Fannie Mae. However, 5% is recommended to avoid restrictions such as getting a loan over the standard $726,200, refinancing a manufactured home, and other limitations.
Start your equity buyout refinanceImpact of interest rate increase
Most borrowers are quite aware of how much interest rates have climbed over the past couple of years. If you refinance for any reason, calculate how the higher rate will impact your payment.
Many homebuyers secured a fixed rate of around 3% before rates began to rise. Let’s take a look at how a rise to 7%, which is where the current mortgage rates are sitting, will affect a monthly payment amount.
Example 1: A $340,000 remaining balance 30-yr mortgage
Payments assume no HOA or PMI, taxes of $280 per month and home insurance of $66 per month.
| Rate | Payment |
| 3% | $1,779 |
| 7% | $2,608 |
| Difference | +$829 |
Example 2: A $520,000 remaining balance 30-yr mortgage
With the same taxes and insurance as above:
| Rate | Payment |
| 3% | $2,686 |
| 7% | $4,000 |
| Difference | +$1,314 |
Equity buyout vs. HELOC for divorce
Another option for a divorce buyout could be a HELOC—a home equity line of credit. But, like the refinancing option, HELOCS are also more appealing when interest rates are low.
These loans have variable rates that are tied to the prime rate. As of now, the prime rate stands at 8.25%. When the Federal Reserve raises its key interest rate, the prime rate also increases.
Currently, the Federal Reserve is making efforts to combat inflation. While it has scaled back its aggressive rate-hiking strategies, there is still a possibility of rate hikes by 0.25% or more in the coming months. Therefore, a HELOC with a rate of prime + 0.25% would be at 8.5%, but it could even rise to 8.75-9% by the end of the year.
Furthermore, an equity buyout mortgage is preferred over a HELOC for divorce because a HELOC won’t remove the spouse from the original mortgage.
See if a divorce settlement HELOC is right for you.Other considerations for an equity buyout refinance
No matter what option you choose, there are a couple of details about the loan that should be emphasized here.
Keep the loan amount and closing costs in mind
When obtaining a loan for the purpose of buying out a spouse's interest in a property, it’s important to consider the necessary funds—to cover both the current mortgage balance and closing costs.
Closing costs could be $5,000 to $10,000 depending on the loan amount and other factors. These costs can either be paid from the equity of the spouse or split between both parties involved.
No cash back for the homeowner
The individual who retains ownership of the home will not receive any cash back.
This means that if one party buys out the equity of another party in a property, the owner keeping the home will not receive any additional funds as part of the transaction.
The primary purpose of this arrangement is to ensure a fair and equitable division of assets and to remove the ex-spouse's name from the loan documents. It’s not to give the remaining spouse extra cash.
Cash-out refinance for divorce vs. equity buyout for divorce—the bottom line
Divorces are never easy. Don’t make the settlement of your home’s equity more difficult or expensive than it needs to be.
See if you qualify for this new equity buyout refinanceOur advise is based on experience in the mortgage industry and we are dedicated to helping you achieve your goal of owning a home. We may receive compensation from partner banks when you view mortgage rates listed on our website.
