How will the 2018 tax reform impact getting a mortgage?

The 2018 Tax Reform Bill brings with it many changes. In the Divorce World, the major change will be that alimony/maintenance is no longer tax deductible in the future.  This specific change may even have a greater affect on divorcing spouses where real estate and mortgage financing are involved. Unfortunately the changes where mortgage financing is involved may not have a positive effect.  Now it is even more important than ever to have a Certified Divorce Lending Professional (CDLP) on your professional divorce team to help identify obstacles and provide guidance to your divorcing clients.  There are two main components of the tax bill that will especially impact divorce mortgage lending.

1. Potential Loss of Mortgage Interest Deduction in Divorce Situations

The extent of the effects of the Tax Reform Bill is not yet completely known for the mortgage industry at this time. Mortgage under-writing guidelines will soon be modified to take into account the effects of the loss of the alimony tax deduction.  Let’s take a deeper look into the Top Two Changes and how they will affect your divorcing clients.

The 2018 Tax Reform Bill has reduced the maximum loan amount on acquisition debt from $1,000,000 to $500,000. This means that mortgage interest on loan amounts up to $500,000 used to purchase or significantly improve the home is tax deductible under the acquisition debt category. Mortgage interest on loan amounts above the $500,000 limit will no longer be tax deductible.

The bigger issue for divorcing clients is when one spouse is ordered to pay the current mortgage on the marital home and is in return allowed to deduct the mortgage interest paid from his/her personal income taxes. Depending upon how ownership and title is held on the marital home may now cause a signification tax concern for the paying spouse.

Previously for divorcing homeowners who jointly owned the marital home, the spouse claiming the mortgage interest deduction was able to deduct 1/2 of the mortgage interest paid as the mortgage interest deduction and the other 1/2 as alimony/maintenance paid. (IRS Pub 504)

If alimony/maintenance paid is no longer allowed as a tax deduction for the paying spouse, what is to happen to the other 1/2 of the mortgage interest deduction? It will be very important to work closely with a tax advisor who specializes in working with divorce clients to help mitigate any negative tax consequences with regards to the mortgage interest deduction.

Caution should also be exercised when changing how ownership/title is held. Please let me know if I can provide additional information to you on the various methods for holding ownership/title on real estate and the effects that divorce can play on this topic as well.

2. Difficulty in Qualifying for a Mortgage for Paying Spouses

Mortgage guidelines frequently change and changes can certainly be expected with regards to the loss of the tax deduction of alimony/maintenance paid. Divorce mortgage lending is quite different than working with your typical borrower as there are many underwriting guidelines specific to divorce situations. The primary effect of the alimony deduction change may certainly have a negative impact on the paying spouses ability to qualify for mortgage financing in the future.

Currently mortgage guidelines allow for alimony/maintenance paid to be calculated as a reduction to income rather than categorized as a liability on the mortgage loan application – because it is a tax deductible expense. This has a tremendous positive effect on the debt to income ratios for the paying spouse. Once the alimony payment is no longer tax deductible, the payment will need to again be listed as a liability and may result in many unqualified mortgage applications.

An ex-husband who is paying his former wife 50% of his gross income as maintenance. He is already at a 50% debt to income ratio without even adding on his new mortgage payment. Having the ability to reduce his gross income first by the maintenance paid would have a completely different outlook.

For example:

  • Sam has a monthly gross income of $10,000. Pays $5,000 in maintenance and has no other consumer debt.

Current Method with Alimony as Tax Deductible Liability:

  • Sam has an effective gross income of $5,000 and can qualify for a mortgage payment up to $2,500. (50% Debt to Income Ratio)

Effect of Removing Alimony as a Tax Deductible Liability:

  • Sam has a monthly gross income of $10,000 and has $5,000 a month as a maintenance liability. Sam is at a 50% debt to income ratio and qualifies for a mortgage payment of ZERO

 

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