Using a HELOC to Pay a Divorce Settlement

Dividing up marital assets is an unpleasant reality of going through a divorce. For most couples, the largest asset they own is their home – particularly their built-up equity.

Without selling, however, splitting this equity can be a challenge. One spouse typically needs to come up with a lump sum divorce settlement to buy out the other's share of the property or other asset.

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Why Use a HELOC to Pay a Divorce Settlement?

If you have a mutually agreed-upon or court-ordered divorce settlement to pay, a home equity line of credit – typically referred to as a HELOC – may be the solution.

Some advantages to using a HELOC to cover a divorce payout include:

• You can access more of your home’s equity than with a cash-out refinance

• It won't affect your existing mortgage, meaning you can keep your current low interest rate

• Most HELOCs allow you to make interest-only payments during the initial draw period, which lasts up to 10 years

• Paying down your settlement balance will free up credit that you can use again as needed

• Upfront fees are less than with most other types of mortgages – you can even find zero-closing-cost HELOC lenders

• It doesn’t take long to open a line of credit; some lenders can get you a HELOC in as little as two weeks

How Does a Divorce Settlement HELOC Work?

A HELOC is a line of credit tied to your home's equity. It's separate from your existing mortgage and will not affect your current interest rate or terms.

Large lenders commonly advertise HELOCs for up to 85% of a property's value. Smaller banks and local credit unions may have HELOCs as high as 100% LTV available.

HELOCs begin with a draw period, which lets you use your line of credit to pay off your divorce settlement. Most lenders allow for interest-only payments during this phase, although if you pay down your principal balance, you can use the credit again if you choose to. The HELOC draw period generally lasts from five to 10 years.

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Following the draw period is the repayment period, which extends up to 20 years. At this point, you can no longer borrow against your line of credit, and whatever balance you have left is amortized over the remaining term.

For Example: Your home is worth $450,000 and has an existing mortgage for $200,000. You and your ex-spouse are splitting the $250,000 equity evenly, and you want to use a HELOC for the $125,000 divorce payout. You qualify for a $125,000 HELOC at an 8% interest rate with a 10-year draw period and a 20-year repayment period.

At a rate of 8%, your required monthly payments during the draw period would be $833. If you maintain the $125,000 principal balance, your payment will increase to $1,046 during the repayment period.

Note: We’re using a constant 8% to simplify calculations, but most HELOCs have a variable interest rate. As the prime rate changes, so will your required payment. This adjustment can occur monthly, including during the repayment period.

Why Not Do a Cash-Out Refinance Instead?

In a perfect world, you could just do a cash-out refinance, withdraw the equity you need for your divorce settlement, and remove your ex-spouse's name from the mortgage (if necessary) at the same time.

Unfortunately, that’s not always a practical option because:

• Many homeowners are locked into ultra-low interest rates, some with mortgages that are below 3%

• Most lenders cap cash-out refinances at 80% of your home’s value, which may not be enough to cover your divorce settlement

If you currently have a low-interest loan, a cash-out refinance at today's rates could skyrocket your monthly payment.

For Example: A $350,000 30-year mortgage at 3% interest would cost you $1,476 per month. That same amount refinanced at a rate of 7% would have a monthly payment of $2,329. If you were to wrap a $100,000 divorce settlement into your refinance, your monthly payment would more than double to $2,994.

In this scenario, it would make much more sense to keep your original mortgage intact and take out a HELOC for the $100,000 divorce settlement. At 8% interest, your monthly payment on the HELOC during the draw phase would be just $667. Combined with your original loan, you’d pay a total of $2,143, saving you over $800 per month compared to the cash-out option.

Debt-to-Income Limits on Cash-Out Refinances

In addition, refinancing your mortgage at a higher interest rate can make it more challenging to qualify for the loan, as the increased monthly payment will drive up your debt-to-income (DTI) ratio. Your DTI gets calculated by dividing your monthly recurring obligations – such as mortgage payments, car loans, and student debt – by your qualifying income.

Most conventional underwriters look for a DTI no higher than 40-45% for cash-out refinances.

Loan-to-Value Limits on Cash-out Refinances

Even though you can get HELOCs for up to the full value of your property, most lenders limit cash-out refinances to 80%.

Say you currently have a loan for $325,000 on your $425,000 home. Your equity is $100,000, and you must pay your ex-spouse $50,000. Cashing out the necessary equity would bring your loan balance up to $375,000 – 88.2% of the property’s value and well above the 80% limit that most lenders abide by. In this situation, it’s unlikely you could qualify for the cash-out refinance that you need.

Disadvantages of Using a HELOC for a Divorce Settlement

While a HELOC may be a fast and practical way to pay off a divorce settlement, there are some downsides:

1. If your ex-spouse is listed on your primary mortgage, you can only remove them by refinancing the primary mortgage or getting your lender to release liability. Opening a HELOC will not change who's responsible for your existing mortgage.

2. HELOCs typically have adjustable rates. This means that your payments can vary monthly in connection with changes to the prime rate. If overall rates rise, so will your monthly payments. With certain lenders, however, it may be possible to lock in a fixed rate for some or all of your divorce settlement HELOC balance.

3. At the end of your HELOC's draw period, your remaining balance is amortized and you begin paying down your principal. This will cause your payments to rise unless you refinance your balance into another HELOC or home equity loan or wrap it into your first mortgage.

Other Ways to Use Home Equity to Fund Your Divorce Payout

Need to tap into your built-up home equity to fund your divorce payout but aren’t sure if getting a HELOC is the right strategy? Here are a couple of other mortgage options to consider:

Home Equity Loan

A home equity loan is another type of second mortgage used to access your built-up equity. Unlike a HELOC, a home equity loan only lets you make a single upfront withdrawal. After that, you begin making amortized principal and interest payments each month, with a term as long as 30 years.

Home equity loan rates are typically fixed, which provides the advantage of predictable monthly payments. However, home equity loans often have a higher initial interest cost than adjustable-rate HELOCs.

Going back to the previous scenario: if you were using a $125,000 30-year home equity loan at 8.5% to cover your divorce settlement, you would make monthly payments of $961 for the life of the loan.

Cash-Out Refinance

Sometimes, a cash-out refinance might be the best option. If you purchased your home or have last refinance since mid-2022 and have enough equity, today’s rates may be comparable to or lower than what you're currently paying.

Also, some homeowners paying off a divorce settlement may be willing to spend more on interest to refinance their ex-spouse off the mortgage altogether. This could even be a mandatory requirement in some agreements and court orders.

Explore Your HELOC and Other Home Equity Options

If you've decided that a HELOC is the best way to pay off your divorce settlement, the next step should be to check current rates and contact HELOC lenders to find out what size line of credit or equity loan you can qualify for. With the right mortgage company, you could have your divorce payout completed in just a few weeks.

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