Negative Equity and Divorce

(See also “How to not lose your house in a divorce“)

The housing crisis has put a large number of homeowners in Nevada underwater - that is they owe more than their house is worth and have negative equity in their home. What happens to this negative equity when a couple divorces?

The short answer is that as a community property state, any assets or liabilities are split equally. So, the negative equity is also split evenly.

However, there are a variety of alternatives for dealing with this. The simplest method is to sell your house - with half of the deficit being assumed by each party - there is then no argument about the amount of negative equity. The problem is that this is a “joint and several” loan so the bank can pursue either party for repayment and the amount may force both of you into bankruptcy.

Another alternative is for one spouse to transfer their ownership interest to the other in exchange for a lesser claim on some other marital assets. For instance, if there is $50,000 of negative equity and a $100K in a 401k account then a spouse may choose to claim only $25,000 of the 401k (instead of $50K) to account for his or her negative share of home equity. The bank would still need to agree to hold the spouse harmless for the debt (which may be unlikely) or the debt could be refinanced (also unlikely) to remove a spouse’s name - the costs of refinancing could be split equally. Of course, this method also assumes the spouses can agree on the amount of negative equity.

***NOTE: some of the joint liability issues will be avoided if the mortgage is just in one spouse’s name - then the other spouse can sign a ‘quit claim’ deed to give 100% ownership to the spouse with the mortgage.

A third  possibility is to agree to sell the house at a later time when equity is positive and split the proceeds. This can be difficult if one spouse continues to live in the house and pay down the mortgage. The agreement may just be to allow any future deficit or gain on the house to be retained solely by the occupying spouse. The downside is that both spouses are still liable for the mortgage. If the retaining spouse misses payments or sells at a loss then the assets of the other spouse are still at risk.

Another possibility is for the house to be rented with the all costs of holding the house (mortgage, taxes, repairs, insurance) not covered by the rent split evenly between the ex-spouses - this would minimize the financial burden until the house could be profitably sold. However, the same problem arises of not trusting the other party to make timely payments but still being liable for the mess.

The final option is to declare bankruptcy. Nevada law allows a certain amount of your property to be exempt from debtors (see here). Since 2005, you cannot apply for Chapter 7 bankruptcy (liquidation of debts) if your income exceeds the median income of a similar-sized family in your community and you have more than $100 per month in “disposable” income. In that case, you need to file for Chapter 13 (reorganization of debts) and create a payment plan for your creditors.

In my case, my ex-wife refused to show the property to prospective buyers and kept the place untidy when possible buyers did eventually get in. It took over a year to close the sale with an out-of-town buyer with equity falling from +100,000 to -$20,000. The very next week the house next door closed for over $100K less than our sale price. Talk about dodging a bullet! With more than $100K of negative equity I think I would have been forced into bankruptcy. As it was, the loss was split 50:50.