How to Use Home Equity to Settle Home Ownership in a Divorce  

Key takeaways: 

• A divorcing spouse who wants to buy out their partner’s ownership stake divorce has several potential ways to tap into home equity for the funds to do so. 
• A home equity agreement can be a solution for spouses who may not be able to qualify for a loan-based option to access home equity.
   

Figuring out how to divide assets in a divorce can be complicated. If you own a home, you’ll need to determine whether to keep or sell the property. Many couples sell, then split the proceeds. But if one spouse wants to keep the house, they will need to find a way to pay the other for their share. 

If you decide to buy out your spouse’s ownership stake, you may be wondering how to finance that transaction. Tapping home equity could be the answer. Here, we’ll look at ways to access your equity, and the pros and cons of using this method to settle home ownership in a divorce. 

Tapping into a growing asset 

Going through a divorce can be both emotionally and financially stressful. The first step might be figuring out how to buy out a spouse’s ownership stake in the family house. For many couples, accessing home equity can offer the solution to this problem.  

To start, understand what home equity is: the difference between the current market value of your home and the amount you owe on it (mortgage and any other debts). In other words, home equity is the portion of your home that you own free and clear. When housing prices increase, home equity increases. 

Thanks to the increases in housing prices, U.S. homeowners now have a collective total or more than $35 trillion in home equity. For those who have owned their homes for many years, this can mean that they are sitting on a major, but illiquid, asset. But today, homeowners have several alternatives for accessing that asset.  

Options 

Couples who have built up equity in their homes and are considering accessing it have a number of options. Three of the available options we’ll review are loan-based, while one – the home equity agreement (HEA) – is not. 

Cash-out refinance

A cash-out refinance involves replacing your existing mortgage with a new, larger one. The difference between the two amounts is provided in cash (the “cash-out”). In a divorce, each spouse might receive half. The one who is looking to keep the house would use the cash to buy out the other’s ownership stake. 

Generally, a cash-out refinance makes sense when the interest rate on the new loan is lower than on the existing loan. If you just bought your home recently, and have a high interest rate on the mortgage, recent rate cuts by the Federal Reserve may mean you’ll see lower rates on mortgages soon. But for homeowners who secured an ultra-low mortgage interest rate a few years ago, a refinance today may be at a higher rate. That means the monthly payment would be higher and that might make a cash-out-refinance a poor option.  

Home Equity Loan

A home equity loan (HEL) provides homeowners with cash up front. They then have a monthly loan payment with a fixed interest rate. That means the rate – and the payment – do not change during the entire term of the loan.

In a divorce situation, the spouse who wants to keep the home would take out an HEL, use the proceeds to buy out the other partner’s ownership stake, and then be left with the monthly payment.  

Qualification for an HEL may present an obstacle for some individuals. Lenders will look at your credit, your debt-to-income (DTI) ratio and your home’s loan-to-value (LTV) ratio in the qualification process. Every lender is different when it comes to evaluating credit, but they’ll usually want to see a credit score of at least 620. Some may require 680. Lower scores mean higher rates, while higher scores net the best rates. 

DTI is the percentage of your monthly income that goes to debt payments. Many lenders require a DTI of no more than 36%, but some may accept one as high as 43%. In addition, lenders often will want to see that someone has stable income. This may be difficult for a spouse who has been a stay-at-home parent, or who has had only part-time or freelance income.  

LTV is the amount of the HEL loan divided by the value of your home. Typically, lenders want to see an LTV of about 85% or lower.  

It is also very important to understand that an HEL uses the home as collateral. That means you have the potential of putting your home at risk of foreclosure should you miss payments for any reason. 

Home Equity Line of Credit (HELOC)

A home equity line of credit works similarly to a credit card in that you can draw (take out cash) up to the amount extended to you as you need it. Since it also is a loan, there will be a monthly payment. And since most HELOCs are variable-rate, the rate – and the monthly payment – can vary over the life of the loan. The qualification criteria are the same as those with home equity loans. HELOCs also use the home as collateral. 

Since a spouse may need an upfront, one-time cash infusion to buy out their partner’s ownership stake, a HELOC may not be the best option to use home equity to settle a divorce.  

Home Equity Agreement

The home equity agreement (HEA) is gaining popularity as a method of accessing equity. Also called a home equity sharing agreement or home equity investment agreement, the HEA is a no-loan way to obtain cash. With an HEA, homeowners receive a cash payment now in exchange for a percentage of their home’s future value. 

So, in a divorce situation, the spouse who wants to keep the home would take out an HEA and use the proceeds to buy out the other partner’s ownership stake. But unlike with a home equity loan, they do not have a monthly payment.  

The homeowner can then buy back the equity at any time during the term of the agreement, which is often 10 years. Many people buy back their equity – in other words, settle up with the HEA provider – when they sell the home. Unlock is unusual in that, with its HEA, homeowners can also buy back their equity in partial payments at any time during the term. 

Accessing home equity without taking on additional monthly debt payments can be a real help to a recently divorced spouse working to establish financial footing. And because an HEA is not a loan, the qualification criteria are different and not as stringent as the requirements for loan-based ways of accessing equity. Credit scores in the 500s may qualify, and income requirements are flexible – meaning that HEAs are available to spouses who may not have full-time traditional jobs or income. 

 Making the decision to use home equity in a divorce 

Before making any decisions, couples would be wise to obtain a formal appraisal on their home so they can accurately determine the amount of equity they have. Then they can look at the qualification criteria and structure of each option to tap their home equity. As with any financial decision, it’s important to look at all pros and cons carefully. 

Accessing that hidden asset from your home can be an effective way to settle home ownership in a divorce. If you want to learn more about the HEA option, check out this guide that explains how to apply.