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Tracy Stewart, CPA

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Peace of mind through financial clarity.

Don’t Let a Judge Do This to You

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A divorcing couple lived in a state that did not enjoy the option of the collaborative law divorce model. They chose to hire litigious attorneys and let the attorneys do the fighting while they retreated to their respective corners, never talking to each other, or so they claimed. (They have three little children, so they must have talked about exchanging them each week.)

Of course, they could not agree on how to divide their property. They had a modest income, a modest house, very little cash, some credit card debt and a couple of retirement accounts. Had they worked collaboratively and with the assistance of a CPA who understands the nuances of divorce financial issues, they could have divided their property in a way that would have achieved both their goals.

This couple eventually ended up in front of a judge, having spent all their cash on their divorce attorneys and even further under credit card debt. The judge divided the property and debts in a manner that he, no doubt, felt was fair and equitable. Unfortunately, is was not financially wise nor was it creative.

This judge divided the property and debts in an overall 60/40 split, with the greater share going to the wife. The husband was granted the home and ordered to pay the wife for her share of the home … with cash and pretty darned quickly, too. His Honor did not inquire as to how the husband was going to get his hands on this $60,000 of cash. He did not inquire as to whether the husband will qualify for a refinance mortgage. Perhaps he did not care. Perhaps he was tired of settling marital disputes for angry, emotional couples who foolishly refuse to talk to one another.

If the husband cannot qualify for a refinance mortgage, he will retain the existing mortgage and the ex- wife’s name will remain on that mortgage obligation. She may be unable to buy a home for herself. Her credit will be tethered to that of her ex-husband as long as her name is still on that mortgage. What mortgage company will wish to give this woman (with a very modest income) a mortgage when she already has one? Furthermore, the husband will have to cash out a sizable portion of his retirement to pay off the wife, incurring unnecessary and avoidable income taxes and penalties.

To me, this is a sad story. This financial debacle was avoidable with collaborative efforts and the aid of a CPA with financial planning expertise, such as a PFS designation. Particular knowledge in divorce issues is a plus. If you are contemplating divorce or in the midst of divorce, stay out of the courtroom. If for no other reason, do it for your own financial security.

Equity in the House

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The equity in your house is the value minus the debt. If you have had the house appraised, that is the value. The debt is the outstanding balance on your mortgage(s).

In a divorce, the amount to be divided is the equity amount. However, the equity amount does not take into consideration the selling costs or the fix-up costs. So, when you are trying to calculate how much money you can have after the house is sold, you need to take the value and subtract from that the debt, the fix-up costs and the selling costs.

If you call your mortgage lender to ask about the outstanding balance on the debt, you can get two numbers. One is the principal amount outstanding and the other is the payoff amount. The former includes any interest due. If you are current on your payments, just use the principal amount. It is simpler. Keep in mind that every day the payoff amount will change due to the interest on the loan. And every time you make a loan payment, both the principal outstanding and the payoff amounts will change.

Check for liens on the property. You can have tax liens or mechanic’s liens on your property without your knowledge. To find out about liens, you can hire a title company to do a search or you can go to your county records office where your deed is recorded.

House Selling Costs on the Inventory

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When creating an inventory or net worth statement for a divorce, some couples prefer to factor in selling costs for the house. Selling costs are deducted from the estimated value of the house. Usually, the person who wants to deduct selling costs is the person who is intending to keep the house. The reduction in house value from the deduction of selling costs means that person has less on his/her column, leaving room for more assets or money to be placed in their column.

The discussion over whether selling costs should be deducted can be a lively one. Couples talk about the likelihood of actually selling the house soon. After all, where do you draw the line on timing? If he/she intends to sell the house within 6 months, then they get to deduct the selling costs now? What if he/she has a change of heart and decides not to sell the house after all? What if he/she plans to sell the house in 4 years after Johnny has gone off to college?

Then there is the discussion of how much are selling costs? Are they only the real estate agent’s commission? Are they all the costs to sell (whatever those are in your geographical area). Do they include fixing up the house, such as repairs and painting? Then there is the differing opinion about whether painting the living room will produce a higher selling price anyway.

I don’t have an answer here. Just issues to consider. Every couple deals with this in their own unique manner.

Valuing the House

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Valuing the house can be a major issue or a minor issue. Couples have some options here.

1. Guess. Some couples just want to guess on the value and they actually agree to that. This amazes me. But, I have to admit, it is cheap. However, I worry that the guestimate is materially inaccurate.

2. Use the property tax value. Here, the market value of the house might be understated. However, I have seen some areas where the property tax value is very close to an appraised value.

3. Get a realtor to estimate the sales value. The risk here is that the realtor will provide an asking price, not a sales value. The asking price will overstate the value.

4. Get a real appraisal. This is the method I favor the most, despite the cost. I like this one best because I feel the parties will be less likely to regret the choice of valuation method if they hire an appraiser. The cost in my general area of Texas ranges from $300 to $700.

If this is a litigated case, there might be two appraisers or realtors because each party hires their own appraiser. But if this is a collaborative case, the parties hire an agreed upon neutral appraiser and agree ahead of time to accept the value. The collaborative attorneys or the collaborative neutral financial professional usually can provide a name or two of neutral appraisers.

The House

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In many families, the house is one of the two largest assets, the retirement accounts being the other. The house can be both an emotional issue and a financial issue.

There are basically four ways to deal with the house.

1. Sell the house during the divorce and split the net proceeds.
2. One person keeps the house, buying out the other. The person getting the house either keeps the house or sells it.
3. Both parties keep the house, but only one lives in the house. At the time of sale, both participate in the net proceeds.

The legal issues over transferring the title to one person are state specific. If a couple cannot simply re-title the house, they may need to refinance the house so as to get one party “off the loan”. Refinancing may be preferable when they want to have a lower monthly payment. The couple may wish to refinance the house prior to the divorce if the lower earning spouse is going to keep the house and cannot qualify for the mortgage on their own.