In many divorce situations, one of the most important and emotional decisions is which party will keep the marital home. In some cases, both parties agree to sell the home and divide the equity. In other cases, one spouse decides to keep the home and then needs to buy out the other spouse’s equity. In order to do this, the spouse keeping the home will need to refinance. The refinance will not only allow the equity buyout, but it will also remove the exiting spouse’s name from the note and title on the home. The divorce decree will typically dictate the division of equity as well as which spouse will be awarded the home and the responsibility of the mortgage. Texas is a community property state and has unique equity laws which can complicate this process. This is where an Owelty Lien can come into play.
A Owelty Lien is a lien created or a financial sum that is ordered to be paid by one party to the other to affect an equitable partition of property in a situation such as divorce. Basically, it is a lien on the entirety of real property that was jointly owned by a husband and wife. (the marital home) The lien must be paid before any proceeds from a sale or refinance are distributed. For example, John and Mary own a home valued at $300K and they owe $240K so they have $60K equity in the property. John wants to keep the home and buy out Mary’s interest. The decree would award John the home and award Mary $30K in equity. John would refinance the loan for $270K which would pay off the current mortgage as well as Mary’s equity. He would be the sole borrower on the note and title to the home and Mary would be removed from the note and title and paid her $30K at closing. This sounds simple, but here is where complications can come into play.
Many borrowers and attorneys believe the best way to get Mary her $30K is to do a cash out refinance. Unfortunately, in this situation, a Texas cash out refinance would not be possible. Here’s why: Texas equity laws limit borrowers from taking more than 20% of the equity of their home. This means the maximum loan amount can be 80% of the appraised value of the home. SO, in the scenario above, the max loan amount could be $240K. (80% of $300K) Wait though…. John needs a loan of $270K to pay off the mortgage AND Mary. He is unable to pull her $30K equity from the home. What if this was already ordered in the decree and the divorce was final? Unless John has $30K cash to pay Mary another way, she is unable to collect the equity amount awarded to her.
Good news though… if John and Mary and their attorneys understand the situation before the decree is final, Mary will be able to use an owelty lien to access her $30K equity in the property. With an owelty lien in place, the loan amount can go up to 95% of the value of the property. John will be able to get a loan for $275K which can pay off his current mortgage, Mary’s $30K and roll in any closing costs. His rate will be the same as any other rate/term refinance and Texas equity laws do not impact the loan. The amount is paid to Mary directly at closing and is shown on the final Closing Disclosure. Win-Win for all parties!
I can’t stress enough how important it is to involve a lender early in the process, so everyone is aware of the exact circumstances and goals of the clients before a decree is written.
Great practical article by Angela. I have done many divorces where this issue has come up, and I did not know the 80% vs. 95% distinction you mentioned in the article. This should be very helpful in the future.