If you are going through a divorce and you have a variable rate associated to your loan be careful. Why? Here are some questions to ask yourself:
- When do you anticipate your interest rate changing?
If you have already experienced a change in the rate then you want to ask yourself whether it has reached the highest rate possible before you and your spouse decided to separate. If not, whoever is the obligor on the loan may experience a bumpy ride (i.e. the rate may go higher) until the loan matures. How do you address this in a divorce proceeding? You will want to incorporate it as a mutual liability so you do not end up responsible for 100% of the change in liability over time.
- Does the loan have a maximum interest rate (a cap) stipulated in the agreement?
If so, you will want to measure the difference between your current interest rate and where it can climb to in the future. This difference is your “liability gap” that you may want to share with your spouse.
- What happens if the interest rate goes down over time?
This can happen and does (just not often enough). In these situations, the benefit of the reduction in the interest rate becomes an asset of the martial estate and subject to negotiation as to how it will be divided among the spouses. It would be important to create a divorce condition to take any decreases in the interest rate over time as an asset that you may or may not want to share with your spouse.
- Are there any pre-payment penalties associated with the variable interest rate loan?
What happens if you pay off the loan early? Will you experience a pre-prepayment penalty? If these are the terms and conditions embedded into your loan agreement while you were married then this clause should be a shared liability between you and your spouse. At a minimum, you may want to incorporate how you handle any pre-payment penalties as divorce conditions within you divorce decree.
- What is the current economic environment or federal reserve policy?
If the economy is growing you can expect the Fed to raise interest rates. Depending on your loan agreement your interest rate may increase. The reverse is true with an economy in recession.
- How long is the timeline to maturity?
With a variable interest rate there is a higher likelihood you will have changes in your payments over time. This could create a financial hiccup for you if you do not incorporate this variable in your divorce decree.
- Do you have any balloon payments associated to your loan?
If your variable interest rate requires periodic balloon payments you want to be careful of missing this point in your divorce decree. Your spouse and you may have been paying the variable interest rate knowing at some point you will have to make a balloon payment. If this is your situation then be sure to incorporate the issue of balloon payments in your divorce decree.
- Will your interest only loan convert to principal and interest in the future?
Some loans have interest only for a period of years (e.g. 10 years) and then convert over to a principal and interest later on. You may have taken out a variable rate loan with interest only payments to manage short term cash flow. Yet, as time marches on, according to your amortization schedule you may be demanded to make principal payments too. These issues need to be incorporated in your divorce.
About the Author
Larry Smith CPA, MBA
Larry is a Founding Partner of Divorce Outcomes, a specialty professional services firm that analyzes, architects and negotiates all of the financial aspects of a divorce.
Since 2003, Larry has worked with divorcing parties as their fiduciary to design sophisticated divorcing strategies that enable clients to preserve and create wealth from their divorce. As a technical financial expert, he uncovers hidden tradable components through various analytical and architectural processes to arrive at desired outcomes. He is an alumni of KPMG and Andersen and has expertise in:
- technical accounting, taxation, business consulting, risk management, M&A
- forensic analysis, performance analytics
- M&A, business valuations, divorce management, family equity transfers, multi-party negotiations, communications management
- advanced process engineering, cognitive performance technologies
If You Have a Question
If you have a question, feel free to contact me at [email protected] or 617-680-5222. The call is free. I will spend 30–60 minutes with you. I will provide you an honest assessment as to where I think you are positioned in your divorce process or answer any questions you have. I may provide you some guidance, insight or advice that you can take with you as you wish. There is no obligation to move forward. The phone call is designed to ease your fears, provide you some options to pursue and a potential road to run on that can lead you down a path to achieve a successful outcome.
About Divorce Outcomes
Divorce Outcomes is a specialty services firm that helps people both domestically and internationally manage all of the financial decisions that arise in a divorce process. We are not attorneys. We are financial experts who partner with our clients as their personal financial advocates. We help our clients:
- manage their divorce process
- uncover hidden financial risks
- architect divorce solutions
- manage ever-changing negotiating positions
- communicate complex financial matters
- close the divorce process as soon as possible
Throughout the process we evaluate our clients’ current wealth-at-risk and architect desired outcomes to best preserve or create wealth.
This communication is for general informational purposes only which may or may not reflect the most current developments. It is not intended to constitute formal advice or a recommended course of action as every person’s situation is unique and different. The information here is not intended to be, and should not be, relied upon by the recipient to make a decision without professional guidance.