Originally published November 2019
Updated May 2022
The family home is often the biggest asset to be divided in a divorce.
If there is significant equity, dividing it can become tricky – you may need to get creative.
This article outlines some of the lesser-known ways to divide the equity in real property.
If you are short on time, you can view the short video below. For a more detailed explanation, read on.
The Simple Case
Typically, when there is equity in the home, that home and the associated equity are awarded to one party in the divorce.
The other party is then compensated by receiving other assets like bank accounts or retirement accounts.
Occasionally there is so much equity, or so few other assets, that this arrangement simply won't work.
What then?
Sell Now
In such a case, it's not uncommon for the parties to agree that the home should be sold immediately and the proceeds of the sale divided evenly between them.
This solution works beautifully if both spouses are willing to sell, the home is in sellable condition, and the local real estate market will allow for a quick sale at a fair price.
But what if one or all of those conditions aren't present?
Sell Later
If the problem is either a depressed local real estate market or a temporary lack of willingness to sell on the part of one spouse, then the parties can agree to sell the property on or before some future day.
For example, maybe it's important to allow older children to finish high school before selling the family home.
In that case, the parties would agree on a date by which the property must be sold and agree on how the proceeds of that sale will be split.
But what if one party needs the cash from the home equity to meet their current needs?
Cash-Out Refinance
A cash-out refinance works well if one spouse wants to remain in the home, but there are not enough other assets to buy out the equity of the other spouse.
This can happen in cases where the home is the most valuable asset owned.
For example, say the home is worth $500,000 and has a mortgage balance of $100,000 remaining.
That makes the equity worth $400,000.
If the wife wants to remain in the home, she'll need to come up with $200,000 to buy out her soon-to-be-ex-husband's share of the equity.
If there aren't other assets that can go in the husband's column, she'll need to access some of that equity through a mortgage refinance.
In this case, the wife would refinance the home using a mortgage of $300,000. That's $100,000 to pay off the existing mortgage and $200,000 cash to buy out her soon-to-be-ex-husband.
But there are cases where this won't work well.
If the party staying in the home isn't able to qualify for or enter into a cash-out refinance, an alternative must be found.
Property Settlement Note
A Property Settlement Note (PSN) is a loan agreement between the spouse keeping the family home and the spouse who is owed compensation for the equity in the home.
It allows the spouse keeping the home to pay out the equity over time.
A PSN is one of the least used tactics for a variety of reasons.
To start, they aren't a well-known option. Second, it adds a layer of complexity to the drafting of a divorce decree.
And third, using a PSN can leave one party open to enforceability issues.[1]
Because the parties agree to each element of the PSN, the note can be quite flexible.
Elements that need to be agreed on include the length (or term) of the note, the rate of interest, the type of payments to be made[2], and the option to pay off the note early.
The term could be short (five years) or long (30 years).
It might include a rate of interest[3] or no interest at all.
Payments might be interest-only for a period of time, or they could include principal and interest from the start.
For example, assume that the wife from our previous example wasn't able to qualify for a cash- out refinance. She and her soon-to-be-ex-husband could agree that she will pay out his equity to him using a PSN.
The PSNs principal would be $200,000[4] payable over 15 years with an interest rate of 4.927%[5].
That means the wife would be responsible for sending her ex-husband a check in the amount of $1,571 each month for 180 months.
If they desire, the parties can agree that the wife may pay off the remaining principal at any time before the loan term is up.
If the wife is expected to have limited cash flow for a period of time, they may agree that she will make interest-only payments during that period, and then begin making principal and interest payments at a later date.
When using a PSN, it's important that the language of your divorce decree be very specific.
You will need to provide your divorce attorney with an amortization schedule[6] and make sure everyone agrees on the due date for the first payment (and each payment after that).
If you and your divorce attorney are struggling to figure out how to divide significant home equity, or you aren't sure about the long-term financial consequences of any of the above options, it may be wise to consult with a Certified Divorce Financial Analyst™ (CDFA®) who can assist in assessing and structuring this element of your case.
[1] For example, the party responsible for making payments may choose to stop making those payments. In that case, the party owed money would have no choice but to take the other to court.
[2] Interest only or principal and interest
[3] To compensate the party owed for waiting to receive their money. The rate of interest should reflect the risk the lending party is taking as well as current market conditions.
[4] His portion of the equity
[5] Based on current mortgage rates
[6] A complete table of periodic loan payments that shows the amount of principal and the amount of interest for each payment until the loan is paid off at the end of its term.
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