How can my son do a cash-out refinance on the house he got in a divorce settlement?

Dear Credible Money Coach,

My son was awarded his home in divorce. Can he refinance it to put it in his name? He also needed to take $80,000 out to pay off his wife. He is having a hard time refinancing the loan on his own. He claims under $30,000 (annual income) from his business. He is the sole proprietor at his shop, which he ran for over 22 years. His credit score is above 800. His home was appraised at $490,000 and he owes $140,000. What is the best option for him to refinance with cash out? — Katherine

Hello Katherine, and thanks for your question. I’m sorry your son is going through this difficult time. Divorce is never easy, and financial worries like keeping a home can make an already unhappy situation even more stressful.

In this kind of situation, it might be a good idea for him to discuss his situation with a real estate attorney. The information I share here will be general in nature, and his situation may require more-specific, expert advice.

That said, here’s what I can tell you about a cash-out refinance after divorce.

Refinancing after divorce

It sounds like the current mortgage on your son’s home may be in both his and his ex-wife’s name, since you mention getting the mortgage in his name only. Refinancing will allow him to pay off the current mortgage and replace it with one that’s in his name.

To refinance, he’ll need to go through the application process. Potential lenders will look at factors like his credit score, credit history, income, and debt-to-income ratio. Normally, a credit score of more than 800 should make it easy to qualify for a conventional mortgage and a competitive interest rate.

But you also mention that your son is self-employed and reports a low annual salary of just $30,000. Since lenders want to be sure that a borrower can afford the monthly payments on a conventional mortgage, it may be difficult to qualify for one with a low income.

Consider an FHA cash-out refinance

With a good credit score, your son might be able to qualify for the best available rates on an FHA refinance loan.

FHA loans are insured by the Federal Housing Administration. They’re generally easier to qualify for than conventional mortgages.

Your son’s credit score is well above the minimum for an FHA refinance (500). And FHA lenders will often work with people who have lower incomes. His DTI ratio will be important when he applies — generally, it’ll need to be no more than 50%, and even lower would be better.

For an FHA cash-out refinance, he’ll need to meet a few other criteria as well:

• He must have lived in the home for at least 12 months before applying.
• The last 12 months of mortgage payments on the home must all have been made on time.
• He must have at least 20% equity in the home.

Note that he won’t be eligible for an FHA Streamline Refinance, which has fewer hoops to jump through, unless the current mortgage is an FHA loan and his name is on it.

Equity requirements for a refinance

Whether it’s a conventional or an FHA refinance, lenders generally require a borrower to have at least 20% equity in the home. And the amount of cash your son can take out will be determined by the home’s value and his existing loan.

Lenders typically won’t let you borrow more than 80% of a home’s value. If your son’s home is worth $490,000, and he owes $140,000 on it, the maximum he could take out would be $252,000 — more than enough to pay his ex-wife. Here’s the math:

• $490,000 x 0.80 = $392,000 (the total amount he can borrow)
• $392,000 - $140,000 (current mortgage amount) = $252,000 (available equity)

Ready to learn more? Check out these articles …

• How much money can you get with a cash-out refinance?
• Should you refinance with your current mortgage lender?
• How to get the best mortgage refinance rates
• Should you pay off your mortgage or invest the money?

This article is intended for general informational and entertainment purposes. Use of this website does not create a professional-client relationship. Any information found on or derived from this website should not be a substitute for and cannot be relied upon as legal, tax, real estate, financial, risk management, or other professional advice. If you require any such advice, please consult with a licensed or knowledgeable professional before taking any action.

About the author: Dan Roccato is a clinical professor of finance at University of San Diego’s Knauss School of Business, Credible Money Coach personal finance expert, a published author, and entrepreneur. He held leadership roles with Merrill Lynch and Morgan Stanley. He’s a noted expert in personal finance, global securities services and corporate stock options. You can find him on LinkedIn.