When both of you are divorcing, you’re short of cash, and all your marital wealth is tied up in one or two large assets, a divorce lien may be a good solution. One spouse keeps the asset; the other gets paper.
In one sense, a divorce lien is nothing new. It’s simply a note payable from the spouse who keeps the major asset (usually the wife who keeps the house) to the spouse who gives it up (usually the husband), secured by a mortgage on the asset.
If you’re using a divorce lien to allow one of you to stay in the house(and let’s assume it’s the wife), here’s how it would work: The husband would deliver to the wife a deed to the house, conveying his share of the ownership. At the same time, the wife would sign a note to the husband agreeing to make periodic payments and/or to pay a sum certain at some point in the future. The wife would also sign a mortgage, called a “deed of trust” in some states. The mortgage would pledge the wife’s interest in the house to back up her promise to pay as provided in the promissory note. This is usually a second mortgage, because the first mortgage stays in effect throughout this transaction.
The wife gets to stay in the house and keep a familiar environment for the children. The husband gets security that, eventually, he will be compensated for the equity he has given up in the house.
The divorce lien doesn’t work for everybody. Here are the elements that must be in place to make a divorce lien a viable option for the two of you:
- You need to have significant equity in the house.
- The spouse who’s keeping the house needs to have a secure income that’s large enough to allow him or her (1) to make all the payments needed for the house, including the mortgage payment, utilities, taxes, and insurance; and (2) to live on what’s left.
- If the spouse who’s giving up an interest in the house needs current cash, the spouse who’s keeping the house also needs to be able to make whatever periodic payments the note requires.
If you and your spouse agree to use a divorce lien, the spouse who’s giving up the house needs to make sure the note he or she gets is negotiable. This is a function of the Uniform Commercial Code (UCC), which is in effect in all 50 states. Here are the requirements for “commercial paper” (the UCC’s term for the note) to be negotiable:
- You have to be able to produce the physical document. A copy doesn’t do it. This means you need to keep the note in a safe place.
- The note must be payable on its face to the spouse.
- It has to call for a sum certain. “Enough to buy another house of similar quality” won’t do. It has to be stated in money (like “$40,000 plus interest at 6% per annum compounded annually”). It doesn’t have to be in U.S. dollars. That is, you can make it in French francs or Canadian dollars or whatever.
- Payment has to be due on a date certain. “When Johnny finishes high school” doesn’t do. Neither does “When [the wife] has an income more than $40,000.”
- The obligation to pay must be unconditional, and it can’t be subject to any offset. This means that it can’t provide, for example, that the payment is net of any deficiency in the payment of alimony. It also can’t provide that payment need not occur unless the husband is current on the payment of child support.
If the spouse’s who’s given up the house wants current cash, and if the note is a negotiable instrument, he or she may be able to sell the note at a discount long before the payments are due on it. For more information about how this might work, you’ll want to check out Wall Street Brokers or their specific site on divorce liens at DivorceLiens.com. They’re in the business of buying privately held notes, including divorce liens.
Wall Street Brokers is conscientious about this, but others may not be. Make sure that when you sell the note, you endorse it “without recourse.” Just add the words “without recourse” to your signature. What this means is that if the buyer of the note has trouble collecting on the note, the buyer won’t be able to come after you for payment. If you just endorse the note and don’t add the words “without recourse,” you have effectively endorsed it “with recourse,” meaning you stay liable for any shortfall. Probably not where you want to be.
Here are the ways to get the best price for your note when you sell it:
- Have a high interest rate (but one that’s manageable for the obligor).
- Provide for monthly payments currently. A small monthly payment that’s actually made currently is better than none at all, even if there’s a substantial balloon at the end.
- If you have a balloon date, make it as soon as possible. The longer the buyer has to wait, the more risk is involved, and the larger the discount that will be included.
You and your spouse will probably both need to get title insurance, so each of you can know that your respective title to the house is clear. Also, make sure the property insurance includes the spouse holding the divorce lien as an additional insured. This usually costs little or nothing.
The divorce lien could work when the asset is a family business instead of a house. The one difficulty that exists here is that the security interest in a family business is more tricky and more difficult to protect. Here are some alternatives. You and your spouse can choose one or more of them, depending on your situation:
- Have the obligor spouse pledge some or all of the stock (or partnership interest) in the business to secure the note.
- Take a security interest in one or more business assets, like real estate, vehicles, equipment, or even accounts receivable or customer lists.
- Often a usiness holds patents, copyrights, or trademarks that it has no intention of selling but that are crucial to the business. These might be pledged to secure the debt.
- Make other part owners of the business liable for payment to the obligee spouse.