Use An Equity Buyout "Divorce Refinance" to Save Money, Qualify Easier
Fannie Mae maintains a little-known rule saying that homeowners who are buying out another owner’s interest – such as in a divorce – do not have to classify the loan as a “cash-out refinance.”
This means better rates, lower fees, and less stringent guidelines.
Here’s how an equity buyout mortgage can help your situation and how to qualify.
Cash-Out vs No-Cash Refinance Designation
You can save a lot of money by getting a no-cash refinance instead of a cash-out one.
Fannie Mae views cash-out loans as risky and raises rates and fees accordingly.
Surprisingly, Fannie Mae classifies partner buyout cash-out refinances as no-cash refinances, even though a very large sum of equity is being taken from the home.
Bottom line is that this seemingly small rule change could save you 0.25% to 0.50% in rate or thousands in closing costs.
How to Qualify for a Divorce Equity Buyout Refinance
Here’s how to classify your refinance as “no-cash” even if you’re taking cash out to buy out an owner’s interest.
The property was jointly owned for the previous 12 months
All parties must sign an agreement stating how much the exiting party will receive
The remaining party must qualify for the new mortgage on his/her own; the former co-owner will not be on the new loan
The remaining party may not receive proceeds from the refinance
Although not a requirement for the program, it’s a good idea to remove the ex-spouse from title at the time of this refinance.
How Much Can You Save By Classifying the Refinance as “No-Cash”?
Assuming a 720 credit score, Fannie Mae tacks on an additional 1.125 points to total loan fees for a cash-out refinance versus a “rate and term” i.e. no-cash refinance. This is $4,500 upfront on a $400,000 loan amount.
Most borrowers take a higher rate in lieu of this cost. The 1.125 additional points translate into about 0.25% to 0.50% higher rate.
On a $400,000 new loan amount, a cash-out refinance would cost about $130 more per month and an extra $20,000 in interest in the first 10 years of the loan.
So, essentially, Fannie Mae just reduced the cost of divorce by at least $20,000 for some couples.
Access More Home Equity
Because the loan qualifies as a “no-cash” refinance, you have access to higher loan amounts.
A cash-out refinance maxes out at 80% loan-to-value. This means the final loan can be only 80% of the home's value.
An equity buyout refinance is allowed up to 95% of the value. You’ll pay mortgage insurance on anything above 80% LTV. But some situations require tapping the maximum amount of home equity, such as when there’s less than about 30-40% equity in the home.
High LTV Equity Buyout Refi Example | |
Current Loan | $400,000 |
Home Value | $475,000 |
Cash Needed for Buyout | $37,500 |
New loan + closing costs | $440,000 |
New LTV | 93% |
Eligible for Equity Buyout Refi? | Yes |
Eligible for Cash-Out Refi? | No |
More Lenient Guidelines
Homeowners with lower credit or income will qualify for the equity buyout mortgage more easily.
Equity Buyout Refi | Cash-Out Refi | |
LTV | 95% | 80% |
Rates | Standard refi rate | 0.25% to 0.50% above standard refi rate |
Approval criteria | Easier to qualify for | Difficult to qualify for |
Debt-to-income ratio | 50% | 45% |
Qualifying for the New Loan
It could be difficult to qualify for the new loan with just one partner’s income. Chances are that two incomes were used to qualify for the existing mortgage.
Now the mortgage amount and possibly the rate are rising.
The payment could rise by $500, $1,000 or more per month. Make sure you can afford the increase.
Also, the new mortgage payment plus all other debt payments can’t exceed 50% of your gross income, or 45% for some borrowers. It’s worth running your numbers with a lending professional before deciding on this loan as an option.
Equity Buyout Refinance Downsides
This isn’t the perfect solution for everyone.
Your rate might double from 3% to 6.5% or higher depending on when you last purchase or refinanced
You may not have enough equity to complete a refinance
High closing costs
You restart your mortgage at 30 years
Will be harder to sell the home later if little equity remains.
It’s certainly could be painful to refinance out of a great mortgage to pay off an ex-spouse. Unfortunately, divorce sometimes requires financial setbacks.
Equity Buyout Alternatives
If an equity buyout refinance does not seem feasible, there are other solutions to buy out an ex-spouse. Keep in mind that only a refinance can remove the spouse from the original mortgage.
HELOC: Some credit unions allow you to cash out up to 100% of your home’s equity with very little closing costs. Plus, it leaves your first mortgage intact.
Personal loan: If you need just $20,000 or so, try a personal loan. It is not attached to the property at all and you can pay it off as you’re able.
Family loan: You can borrow money from a family member for an ex-spouse buyout.
Apply for an Equity Buyout Refinance
Divorce is never fun, but at least it’s a little easier thanks to this new tool from Fannie Mae.
Check with a lender to see if you’re eligible.
