Divorcing in the midst of an underwater mortgage?

A Maryland divorce is difficult enough in its own right, but what happens when the couple obtaining the divorce has financial difficulties as well? In particular, how do they go about dealing with a marital residence when the couple owes the bank more than the current fair market value of the home? These property division issues are often more complicated than they first appear and deserve special attention when negotiating an equitable divorce settlement.

In circumstances where one party to the divorce wants to keep the marital home which is in the midst of an underwater mortgage, there are several alternatives to figure out how to divide up the debt. One scenario simply gives that party a credit equal to the amount owed on the mortgage that exceeds the home's value, and this credit is typically applied to another asset subject to property division. Thus, if a mortgage is underwater to the tune of $100,000 and assets are to be divided equally, then the person keeping the home would get a $100,000 credit on another item of property. If, say, a retirement fund of $400,000 was to be split equally, the spouse ceding the interest in the home would have his or her interest in the retirement asset debited by $100,000 to equal out the underwater mortgage debt.

But this approach may not always be fair, since the person keeping the home can often recoup a paper loss once real estate values improve. To avoid this potential inequity, some suggest the amount underwater on a mortgage ought to be zeroed out, meaning that no credit be given since the person keeping the home will likely eventually make up for the loss. This approach, though, is dependant on the state laws where the divorce is pending, as not all states allow for a liability to essentially be ignored.

A short sale is another option. Here, the couple simply agrees to sell the home and seek the lender's approval. However, it is important to know beforehand that bank approval includes forgiveness of any balance not met on the underlying mortgage through the short sale. Further there are potential tax consequences that must be considered to arrive at a fair resolution of all divorce property division issues, in Maryland or elsewhere.

Source: gobankingrates.com, "Handling an Underwater Mortgage When Your Marriage is on the Rocks," Casey Bond, May 2, 2012