Written by Kimberly R. Nelson, C.F.A., C.D.F.A.
When I sit down with clients who are considering a divorce or already have the ball rolling, I have learned that deciding what to do with the family home has far more to do with emotions than it does with practical financial planning. Our homes are our refuge from the world, where the anxieties, injustices, or failures we’ve experienced throughout the day just seem to melt away, and are replaced by comfort and security.
It is the place where you’ve raised your children, spent some of your happiest moments, and is perhaps a very tangible reminder of a marriage that was supposed to be your happy ever after.
Allowing your emotions to drive your decision-making regarding the family home may cloud your judgement and lead you to make the wrong choice. Staying in your home for fear of disrupting your kids’ routine could actually cause far more disruption than starting over in a new home you can afford. Before you decide if you should stay or go, you need to ask yourself these five questions:
1. Why do I want to stay in my home?
Are you staying only because you are worried about further upheaval in your kids’ lives? Is it because you think moving is going to create even more trauma? Is there a part of you that thinks keeping your kids (and yourself) in the same environment will somehow make this enormous life-shift less monumental?
The truth is, you have to get really honest with yourself about the reasons you want to keep the house. No single reason is necessarily right or wrong. Some reasons are financial. Some are very intensely personal. Regardless of why you may want to stay in your home, if you are going broke to do so, you will wind up creating a far more stressful environment for your family than if you had just decided to move out.
If your kids’ feelings are your primary motivation, then make them a part of this decision. Explain your new financial reality to them, and why it may be best to find a new home where new memories can be created. Ask what is most important to them. You might find that what they are really seeking is the comfort of what lies within the four walls of your home, and not necessarily the structure itself. A home is what you create with your family. It’s a feeling, not just a residence.
2. Is it really “home sweet home,” or just a big money pit?
If you’ve seen the 1980s movie The Money Pit, you’ll remember how a hapless couple poured all of their money into a home that was falling apart. Hopefully you don’t encounter the same problems that Walter and Anna did if you decide to keep the home in your divorce settlement, but it could nonetheless wind up becoming a modern-day money pit if you don’t carefully consider all of the repercussions.
If keeping the family home means giving up all other liquid assets to your spouse, you could be signing up for a hefty monthly mortgage obligation with no real cash to make the ensuing payments. I’ve seen this time and time again, especially in my home state of California where housing prices are sky high.
These days, our homes tend to comprise the majority of our wealth, so it’s possible that keeping the home may require you to pay out your spouse on their portion of the equity through a cash-out refinance. This option actually creates an even larger debt on the property than you and your spouse carried together when you were married. Making a bigger mortgage payment with less income is likely not feasible, and might not allow you to comfortably provide the same lifestyle you and your children enjoyed pre-divorce.
3. Can I afford a house payment post-divorce?
There are a number of factors to consider in determining your ability to maintain the family home after your spouse has set up a household elsewhere and you are now on your own. You are essentially running the same household on a fraction of the former family budget, and this can be a very difficult balancing act. Be realistic and know your expenses. If you haven’t sat down with a pen and paper and drafted your new post-separation budget, you must do so before making any decisions regarding the home. This is also a great time to consult with a financial advisor, who can help you sort through your new financial reality and help you make these decisions objectively instead of emotionally.
4. Am I signing up for a huge tax liability?
I was introduced to one of my clients about two years after she went through particularly painful divorce. She had been hellbent on keeping the home that she and her husband bought when their daughters were very young. It was a beautiful home in a beach community in Los Angeles that was purchased for 3.3M, with a 2.2M mortgage. At the time of the separation, the home was worth about 5.5M, and the mortgage was paid down to about 2.0M. After reviewing her financial situation, she heeded my (gentle, albeit firm) advice to sell and move to something smaller. The finalization of the divorce left her with about 1.0M in cash, a beautiful beach home, and an enormous monthly mortgage and tax bill. Two years after giving her ex-husband a majority of their liquid assets in exchange for the home, she finally came around and realized that the house was creating far more insecurity than stability for her and her kids, and it was time to let go. After paying close to $400,000 in commissions and closing costs, she made a profit of about $3.1M of which she owed nearly 1M in taxes. In short, the asset that was valued at $3.5M on her side of the balance sheet during the divorce negotiation only yielded her about $2.1M when all was said and done. So, what went wrong here?
This is one of those “disasters in disguise” that may take an expert’s knowledge to help you avoid it. As couples are slicing up their estate and moving assets on either side of the newly created “Mine and Yours” balance sheet, they (and often their attorneys) forget about the mechanics of the capital gains exemption of the home.
If you and your spouse sell your home during the divorce, you are able to take a $500,000 combined capital gains tax exemption on the sale profits. If you take the home on your own and decide to sell it down the road, you will only be able to utilize the single tax exemption of $250,000. This could mean tens of thousands of extra dollars going to taxes when you are ready to move on. Not to mention that you will solely bear the cost of the transaction (closing costs, brokerage commissions, etc.). Selling the house now and splitting the profits (and any associated costs) with your soon-to-be ex may be the smartest financial move in the long run.
Had my client been counseled to sell the house with her ex-husband before the ink was dry on the divorce decree, they would have had a combined exemption of $500,000 (as the house was their joint primary residence) and they would have shared the cost of the selling fees. My client’s half of the savings would have amounted to nearly $300,000.
5. Can I refinance on my own?
Qualifying for a mortgage on your own without your spouses’ income can be challenging, especially if you are the lesser-earning spouse or significantly dependent on either child support or alimony for your living expenses. Banks typically like to see at least six months of support payments coming in before they will qualify that income toward your debt-to-income ratio calculation, and they will usually require that support payments are scheduled to continue for 3 years after the loan closes. This could mean that you would need to wait 6 months until after your divorce is finalized before you begin seeking the refinance. For various reasons, credit scores can also be negatively impacted during and after divorce proceedings, making it more difficult to refinance.
Are there good reasons for you to stay in your home post divorce? Yes. But are there a lot of things you need to consider before deciding? Absolutely. Take your time and utilize all of the resources available to you: your lawyer, accountant, financial planner, and a trusted friend or family member. If you do all of these things and ask yourself the hard questions, you will be fully equipped to make the best choice for you and your family.
About the Author:
Kimberly Nelson is a Los Angeles-based wealth planner and investment advisor, empowering divorcees with the education and motivation to take control of their financial lives and build their wealth. You can find her here or by email at firstname.lastname@example.org.