February 28, 2015


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February 26, 2015

Lowndes Drosdick Doster Kantor & Reed

Divorce: What to do with a house that's underwater?

What happens when one spouse wants to keep the marital home in a divorce settlement, but the parties owe more on their mortgage than the home is worth? This is, unfortunately, a very common problem (often referred to as having an “underwater” mortgage or “negative equity”), as almost two million Floridians are in this situation.[1] This means that approximately 45% of the state’s total mortgages are currently underwater, while another 4.1% are closely approaching negative equity. It is also believed that Central Florida’s negative equity rate is even higher than the state average, with 53% of mortgages currently underwater in the Orlando area.[2] Since approximately one-half of all Floridian homeowners are faced with this problem, the question of how to handle a home with negative equity in a divorce is frequently becoming an issue.

Florida law states that, unless circumstances warrant differently, spouses going through a divorce should each have an “equitable distribution” of the marital assets and liabilities, with a starting premise that the division should be equal.[3] In a divorce settlement where one spouse keeps the marital home, and the home has positive equity, the amount of equity in the home is counted towards that spouse’s portion of the property distribution. However, when a home is underwater and one spouse wants to keep it, lawyers and judges are struggling with the question of whether to allow that spouse to count the amount of negative equity toward their distribution of marital assets and liabilities. If this is permitted, that spouse will receive more of another asset in order to make up for the debt from the house that he or she is taking on, so that the overall property distribution is equalized. Certain Central Florida judges, however, have recently commented that, in a divorce case where the house has negative equity, the judge may decide to “zero” out the debt from the house, so that the spouse taking on the home will not receive the credit for the mortgage debt he or she is taking on. Of course, parties are also free to do this in out-of-court settlements, and may agree to zero out the mortgage or settle on some number between zero and the amount of the negative equity during settlement negotiations, depending on the specific circumstances of the case.

There are two main reasons behind the concept of “zeroing” out an underwater mortgage. The first main reason is that it is very possible that the home may be foreclosed or short sold in the future, and the spouse keeping the home may not, in reality, have to pay the entire deficiency amount. The other reason is that the value of the home will likely increase as the housing market recovers, so that the spouse keeping the home will realize that value at some point and will not be held to the entire deficiency amount existing at the time of the divorce. Thus, the spouse keeping the home would receive the benefit of taking on the mortgage debt in the divorce settlement, but may not actually have to pay all or some portion of the debt in reality, resulting in a potentially unfair property distribution.

While this “zeroing” argument may seem logical in many cases, especially those where it is foreseeable that a foreclosure or short sale will actually occur in the near future, or where the spouse intends to keep the house as a long-term investment and will likely realize an increase in value as the economy recovers, case law in Florida still says that all marital debts must be distributed. Florida law is clear that “the first step in distributing a marital couple’s liabilities in a dissolution action requires the trial court to identify them. The second step requires the court to designate them as either marital or non-marital. The third step is to equitably distribute them.” Another Florida court echoed in 2008 that “it is reversible error for the trial court to fail to identify and distribute each marital asset and liability.” Therefore, pursuant to this case law, it seems that a judge should account for the actual negative equity being taken on by one spouse, instead of zeroing out the debt altogether. Realistically, however, that might not be equitable in many cases. It seems as though Florida judges have begun zeroing out underwater mortgages in some divorce cases, and it is thus very possible that a Florida appellate court will either uphold or overturn a trial court’s decision to zero out a home with negative equity in the near future. Until then, it is unclear how individual cases will be settled or decided. The law says one thing, but, given the current economic circumstances, fairness may often require another. Family law courts are courts of equity, and thus, the totality of the circumstances must be weighed.

[1] CoreLogic, Q2 2011 Negative Equity by State, corelogic.com. CoreLogic is a real estate data and analytics company based in Santa Ana, CA.

[2] Kim Miller, Nearly 2 million Florida mortgages underwater, The Palm Beach Post, September 13, 2011, http://blogs.palmbeachpost.com/realtime/2011/09/13/nearly-2-million-flor...

[3] Florida Statute § 61.075 (2011).

If you are going through a divorce and have questions about a “underwater” mortgage or “negative equity”, please contact Rebecca Palmer or any other member of the Family Law practice at our family law line: 407.418.6482.