Your Mortgage : In Divorce Case, Lenders Seek Security

QUESTION: My daughter and her ex-spouse are co-owners of a house and a condominium. In their divorce proceedings, a settlement was reached whereby for a sum of money he would relinquish his rights to both properties to my daughter. The money is available. There is a 13-year mortgage on the house at a 7 1/2% interest rate and a 23-year mortgage on the condominium at a 9 1/2% interest rate. The mortgage companies tell us that to relieve the ex-husband from his liability, my daughter would have to refinance the house and the condominium at current rates, paying closing costs and points. This is an extra expense that my daughter cannot afford. Do you have any suggestions?

ANSWER: This is a very common problem. When a husband and wife divorce, and the parties agree that one of them will own the property, we often forget that there is a lender in the picture who wants to keep both parties responsible while the original loan stays on the books.

This is especially true when the initial interest rate is low (such as in your case it is 7 1/2%) and clearly the lender can get a better rate today by requiring your daughter to refinance the property.

The lender’s rationale makes sense. Your daughter and her then-husband made application for a mortgage loan, and presumably both qualified. Through no fault of the lender, the parties are divorced, and have agreed that the house would go to your daughter. However, the lender is not obligated to remove the former husband from the loan, as long as that loan stays on the books.

Clearly, the simplest way to resolve this is for your daughter to refinance, transfer the title into her name. If she qualifies for a new loan she will be solely responsible for those payments.

Many years ago, lenders took the position that when there was a transfer between a husband and a wife in connection with a divorce situation, that transfer triggered the “due on sale” clause. This clause, which has been upheld in many states throughout the country, basically states that the loan becomes fully due on the sale (or transfer) of the property.

The purpose of this clause, from the lender’s point of view, was to prohibit assumptions. For example, in your daughter’s case, one of the mortgages is 7 1/2%. If your daughter and her former husband sold the property to a third party, in the absence of a “due on sale” clause, that third party could assume the low-interest loan. With the existence of a “due on sale” clause, the loan cannot be automatically assumed without the lender’s permission.

However, in 1982, Congress specifically addressed the “due on sale” clause, and made it clear that for most loans, the lender could not enforce a “due on sale” clause on residential real property containing less than five dwelling units when the transfer or sale results from a decree of dissolution of marriage, a legal separation agreement, or from an incidental property settlement agreement by which the spouse of the borrower becomes an owner of the property.

Thus, one of your problems has been solved by this congressional law.

However, even if the lender cannot enforce the “due on sale” clause, when the former husband transfers his interest to your daughter, the lender does not have to relieve him from his responsibilities and obligations under the original note which he signed when they first bought the property.

In order to relieve him from that liability, the only solution is for your daughter to refinance, and get a new loan in her name only.

You should discuss this with the lender, but I doubt that the lender will want to cooperate.

However, from your daughter’s point of view, unless the divorce decree or property settlement agreement specifically requires as a condition of transferring the property that the husband be relieved from his financial liabilities to the lender, it would be my opinion that your daughter’s former husband should transfer the property to your daughter, and bear the consequences of being secondarily liable in the event your daughter cannot make the monthly payments.

What are the consequences to her former husband?

Oversimplified, I can foresee two potential problems.

First, if your daughter cannot make the monthly payments, and if the house is sold at a foreclosure sale for less than the amount owed to the lender, the lender might be able to go after both your daughter and her former husband for what is known as a deficiency judgment.

Second, and perhaps of greater concern, the former husband may have trouble qualifying for another mortgage loan in his own name, because of the potential liability on the current mortgage. However, my experience has been that many lenders will waive this problem, especially if the former spouse has the financial ability to qualify for the new loan.

I also recommend that your daughter discuss the tax consequences with her financial and legal advisers before accepting title to the property.

Average Rates for Residential Mortgages

Average rates for residential mortgages as of Aug. 16, 1991.

Survey Conventional Mortgages Adjustable Mortgages Area 15 Year 30 Year Composite 1 Year Composite National 8.93% 9.26% 9.11% 6.95% 7.25% California 9.10 9.41 9.26 7.12 7.17 Connecticut 8.94 9.26 9.13 6.90 7.12 Wash. D.C. 8.88 9.19 9.04 6.73 7.14 Florida 8.90 9.27 9.09 6.93 7.21 Mass. 8.90 9.20 9.06 6.84 7.33 New Jersey 8.88 9.22 9.06 6.94 7.44 N.Y. Metro 8.96 9.29 9.14 6.97 7.35 New York 9.05 9.37 9.22 7.01 7.34 N.Y. Co-ops 9.18 9.47 9.43 7.58 8.00 Pa. 8.70 9.07 8.90 6.75 6.98 Texas 8.87 9.20 9.04 6.92 7.13

SOURCE: HSH Associates, Butler, N.J.