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Divorcing with an underwater mortgage? What you need to know

If you and your spouse are divorcing and own property together, chances are you will wind up selling it and splitting the proceeds, or one spouse will buy the other out.

However, if the two of you are buying a property where there is no equity, the process will be a bit different. The real estate market is certainly better now than it was a decade ago, but it is still shaky. With property where there is zero equity, the wisest choice is likely going to be to sell the property and both walk away empty-handed.

But before that step can be taken, a property appraisal is necessary to determine the exact value of the home. If one spouse is determined to keep the property and refinance it in only his or her name, this would factor into property settlement agreements, because while it may be a quarter million dollar asset, it is encumbered by a quarter million dollar debt.

One spouse may gamble that market fluctuations over time will inflate the property's value enough to take the risk. Any future profits from the sale would be solely directed to the spouse who refinanced and kept the property. Conversely, if the market bottoms out again, he or she could wind up going down in financial flames.

The worst case scenario facing divorcing homeowners is an underwater mortgage, meaning that there is more owed on the property than it is worth. When one spouse takes on the refinanced debt, there is no potential asset to balance the scale, and the other spouse has a liability for his or her portion of the deficit.

This can be offset by awarding other assets to the debt-encumbered spouse in the amount of one-half of the deficit. Another solution would be for the other spouse to assume other debts in the amount of half the liability. A sale of the home with a resulting balance owed to the lender would be split equitably between the parties.

If you are facing such a scenario, the attorney handling your divorce may be able to advise you further about the matter.

Source: Zacks.com, "Divorcing With a Home With No Equity," Beverly Bird, accessed June 17, 2015

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