Have you ever seen the cartoon where two surgeons are having the following conversation at a funeral?
Surgeon #1: “I thought you said the surgery was successful.”
Surgeon #2: “It was. He died in recovery.”
A similar cartoon could be written using divorce lawyers. Their charge was successful: The couple is no longer married, but they continue to be adversely affected by surprises related to the divorce. Namely, their separate ability to obtain a mortgage as individuals.
The financial terms of a divorce seem pretty straight- forward. Party A is required to pay Party B a specific amount of money for a specific period of time. However, many lenders throw common sense out the window when reviewing the creditworthiness of an individual obligated to make alimony payments.
For example, let’s assume someone’s divorce decree requires him or her to pay $5,000/month in alimony. Conventional wisdom dictates that a lender would evaluate this person’s creditworthiness by deducting the alimony payment from their monthly income.
But, that would be an erroneous assumption. Many lenders do not consider alimony payments to be an income deduction; they consider the payments to be a monthly liability. The nuance of this classification will often cause a loan application to be denied.
Why? Because a payment liability of $1/month requires an income offset of almost $3/month. In our example, an alimony payment of $5,000/month requires an income offset of almost $15,000/month. If our loan applicant earned $16,000/month, then only $1,000/ month remains for future mortgage payments (i.e.$16,000 – $15,000 = $1,000). With “verifiable”income of only $1,000/month, the applicant would not satisfy the lender’s debt-to-income ratios. It sounds crazy, but this is a standard underwriting guideline for many lenders.
Lenders may also have stringent underwriting guidelines for recognizing the receipt of alimony income.
These guidelines include, but are not limited to:
- The alimony must continue for at least three years after the purchase date,
- The alimony must be stable and received in a timely manner
- The alimony must be seasoned 12 months (i.e. it must commence 12 months prior to the loan’s application date).
If the borrower is unable to satisfy these requirements, then the lender will not recognize their alimony income.
The intent of a divorce is to bring closure to an irreconcilable marriage. However, closure is not achieved if surprises related to the divorce continue to surface.
The terms of a divorce decree may contribute to a big surprise: the denial of a mortgage application. Prior to finalizing a divorce, it is important that both parties understand how the decree will affect their future borrowing capacity. If the divorce has already been finalized, then it is important that divorced borrowers work with lenders that have common sense underwriting guidelines.