No Credit for Negative Equity in Michigan Divorce Cases

The Issue The married parties own a home or other real estate that has an appraised value that is lower than the amount of secured debt owed on the home. This is often referred to as being “upside down” on your home. If one spouse keeps the property in the divorce, can they request a credit against other savings or assets for their assumption of this negative equity? The Apparent Answer There is no currently published (or unpublished) court of appeals or supreme court decisions in Michigan directly addressing this relatively new phenomenon. It appears that the circuit court judges are not willing to grant the party that assumes this potential liability a credit against other assets. There are several potential reasons behind these decisions. 1.The parties are both still liable on the note or underlying debt. Even if there is a hold-harmless or indemnification clause, if the party that takes the house then walks away and stops paying, the note holder (bank) can still sue both parties on the debt. The divorce judgment cannot force the bank to remove one of the parties from the liability associated with the same and if the parties owe more money on the home than it is worth, in most cases the bank won’t agree to remove one name or allow refinancing. So the party that does not keep the house may still be sued on the liability despite the divorce judgment and the hold harmless clause may be useless if the spouse that kept the house is “uncollectable”. Finally, if this situation occurs and the spouse that kept the house was given additional property to credit them for this liability, then the other spouse is facing a double loss, the loss of the property and getting sued for the deficiency by the bank. 2.The court believes that there is greater value to the party that keeps the house than the appraised value. The court looks at the holder’s value of the property rather than the appraised value. The court thinks that if the person is willing to keep the house despite this apparent negative equity that it must be worth more to that person than the general home buying public, perhaps due to the children’s school, some amenities in the house or the party really just doesn’t want to move. 3.The court may look at the house like the stock market, the value is down now but it will go up. If one party wants to keep the house, then they must bear the risk of loss as well as the potential benefit of gain. There are likely other reasons that the courts have not wanted to grant a credit for the negative equity, but these are some potential reasons. Solutions to the Negative Equity Issue 1.The parties can sell the house and come to the table with money from joint funds for the deficiency between the proceeds from the sale and the overall debt. 2.One party can keep the house and then agree to sell it in a set number of years to wait and see if the market goes up and then divide either the debt or the gain. The parties must then decide what will happen if the spouse responsible for paying the debt defaults and how to handle the payment of taxes and the deductions for payment of the mortgage. 3.The parties could short sell the home. In a short sale, one of the parties will have to include the difference between the sale price and the debt as income on their tax returns. The parties must work out a mechanism to share the taxes on this reported income. 4.Finally, both parties could walk away from the home, allow the foreclosure and both will potentially face the bank filing a complaint against them to collect the deficiency in the future. These are only some potential ways of dealing with this solution. The parties divorce lawyer must be creative but practical as there are several potential pitfalls in this evolving area of divorce law.

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