Divorce Liens on the Family Home
|If you are getting a divorce, or know someone who is getting a divorce, you will find it helpful to know about divorce liens. A divorce lien can avoid the usual turmoil of selling the house and splitting the money - the home often being a divorcing couple's largest single asset. With a divorce lien, one party keeps the house, and the other gets a note and deed of trust (or mortgage) secured by the property. One gets real estate and the other gets paper. |
In this arrangement, the spouse who keeps the home, often the wife, has the same familiar environment for herself and the children. The children don't have to change schools. There are no divorce relocation costs. She retains a fair share of the equity and hope that the price of the home goes up. She has the obligation to pay the departing spouse according to an agreed-upon schedule.
The departing spouse, often the husband, signs a deed to the house over to the wife, and in return gets a note and a deed of trust secured by the home - a divorce lien. The departing spouse can hold the note until it pays off, or he can sell it for cash. If the departing spouse has no need for immediate cash, he can accept a payoff, in many cases in about five years, or when the youngest child is eighteen. If the departing spouse does need immediate cash, he can sell the note and ordinarily receive tax-free money. This provides funding for new living quarters, help in paying attorney fees, child support, and a new start in life. If he sells the note, this financial connection to the house ends.
This win-win scenario can ease the pain of a divorce to some small degree. However, a divorce lien is not for every case. The divorcing couple's situation must meet some guidelines. First, the family must have substantial equity in their home. Second, the spouse who retains the home must be able to afford property maintenance and the payments on the first mortgage - a divorce lien is usually a second mortgage. Since a divorce lien also requires a certain minimum of cooperation between the divorcing spouses, you will recognize at the outset that some divorcing couples may not agree to this approach. When it is possible, it gives benefits to both parties that would not otherwise be available.
How to Create a Divorce Lien
You need specialized knowledge in order to structure a divorce lien properly. Both parties need to understand these basics. A divorce lien is based upon a deed, a note and a deed of trust (or mortgage). The departing spouse deeds the property over to the remaining spouse, who continues to live in the house. The remaining spouse signs a note payable to the order of the departing spouse and gives a deed of trust secured by the property. This arrangement, if properly structured, will result in a note which is a valuable asset that can be sold for cash.
First and foremost, the note must be salable and both spouses must be informed that the note is intended to be a valuable asset that can be sold for cash. Once everybody understands that fundamental fact, attention can be focused on how to make sure the note is actually salable. There are many technicalities that can render such a note unsalable or less valuable.
The proper procedure to assure the note's salability begins with the departing spouse - we will assume it is the husband in this discussion - conveying title to the property by signing a deed to the remaining spouse - the wife. The husband and wife must provide all documents required by law to get the deed recorded. This could include affidavits, excise tax forms, or other required items, depending upon the laws of the State in which the family home is located. While this deed is being prepared for recording, simultaneously a note and deed of trust will be prepared for the wife to sign in favor of the husband. Special care must be exercised in preparing the note, because its salability depends on these crucial factors.
The first thing is the husband should be warned that the original note that he will receive must be kept in a safe place in his possession. If it is lost, stolen or destroyed, a copy will not suffice. He will not be able to sell it. Even if he does not want to sell the note, not having it in his possession may hinder his ability to enforce his rights. In preparing the actual language of the note, it should be a negotiable instrument whenever possible.
The first rule of negotiability is that the note must include a time certain when the note is due. A time certain is an exact date, such as December 31, 2007. It is not an event such as "when the house sells," or "when the wife remarries," or "when the youngest child is eighteen," or "upon the death of the wife." If an event is written rather than a time certain in the note, the note will not be a negotiable instrument and it will have little or no cash value.
The next rule of negotiability is that the note must be written so that it is not governed by or subject to any other agreements, terms, conditions or events. In a divorce situation, it is a common practice to write the note governed by or subject to the dissolution agreement. If the note is written subject to or governed by any other document, it will make the note non-negotiable.
It is particularly important to avoid making the note subject to claims, modifications, or offsets of the wife. The most common problems include making the note subject to the future performance of the husband, such as allowing the wife to collect any unpaid child support from the balance due on the note. Another common problem is to give the wife first right of refusal to buy the note at a discount if the husband wants to sell it. If the note is written subject to any claims, modifications or offsets, the note will not be a negotiable instrument and will have little or no cash value. If a specific case requires creation of a non-negotiable instrument, the note will most likely be unsalable, but in some circumstances may still be salable for a much lower amount.
You should also know how to create a note that can bring the highest cash price. Keep in mind these three principles based on the time value of money: A note is worth more if it has monthly payments instead of just one lump sum, if it has a short term to the payoff date, and if it has a high interest rate. If the wife can afford to make monthly payments on the note rather than one large balloon payment at the end of its term, the note will bring a higher price. However, most divorce lien notes do not have monthly payments because the wife's financial situation does not allow it.
If the note can be created with a term of no more than five years, it will bring a higher cash price than one with a longer term. The higher the interest rate on the note, the higher the cash price will be. A note with no interest may fulfill the divorce settlement, but it will result in a deep discount in the event the note must be sold. At the other end of the range, the highest legal interest rate may prove to be more than the wife can actually pay off when the house sells - the interest could eat up all of her equity so that the sale price of the house could not cover the balance due on a high-interest divorce lien note. Thus, the best interest rate for top value is the highest practical rate, taking into consideration the economic realities of the case.
If the note extends beyond a one-year time period without any payment, it must specify exactly how the interest is to be calculated, either simple or compounded annually. Simple interest is calculated on the original amount of the note, whereas annually compounded interest adds interest to the principal balance each year, so that the previous year's interest becomes part of the next year's principal - earning interest on interest. Failure to specify the interest calculation method will result in a note buyer basing the note's value on simple interest, which will lower the cash price.
When the documents are complete and signed, the deed is recorded first, then the deed of trust. The note is given to the departing spouse. This is the time for each of the two parties to buy title insurance. The wife should get an owner's policy and the husband a mortgagee's policy. They usually don't want to pay this expense, but it is a vital protection for each of them. Divorces routinely make couples secretive about financial matters, and a title insurance policy will make sure that neither of them has conveyed or encumbered the property without the knowledge of the other.
The fire insurance on the house needs to be changed at this time, making the wife the insured and the husband the mortgagee. This usually doesn't cost any money. It's a good idea to contact the first lien holder to which both husband and wife are obligated to pay. The husband can request that he be released from liability. The first lien holder is not likely to do so, however, unless the wife can qualify financially to pay the payments without the income of the husband. Sometimes, the first lien holder will agree to do so after payments from the wife have been promptly received for a certain amount of time - for example, two years. The wife should sign permission for the husband to have access to information about the first lien mortgage until the divorce lien is paid off.
Clearly, a divorce lien is an excellent solution to the emotionally and financially draining problem of property settlement. Divorce liens can be created on other assets besides the family home. For example, investment properties and businesses can be divided in a similar manner. Of course, it is imperative that the creation of the divorce lien should be reviewed by attorneys for both the husband and wife, to ensure the house is deeded properly and the lien is structured properly.
This information can be useful to:
Certified Divorce Planners
Real Estate Agents
The information is summarized from over 31 years of experience. It will prove invaluable to individuals and professionals involved in structuring a divorce lien.
|Lorelei Stevens is president of Wall Street Brokers, Inc. in Seattle, Washington. She has been a licensed real estate broker (Washington State Real Estate Brokers License WA-LL-SB-*275LD) and a discounted note buyer since the 1970s. She has worked her entire adult life with Wall Street Brokers negotiating millions of dollars of paper and is a nationally recognized expert. |
Lorelei has taught Legal Continuing Education seminars and has written numerous articles for legal, real estate and other professional publications on the subjects of seller-financing, managing, reinforcing and buying paper. She is the author of two books, one on seller-financing and another on note buying. She also writes a monthly column for Noteworthy Newsletter and is a frequent contributor to The Paper Source. Her web site is www.WallStreetBrokers.com.
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