When the House Has No Equity: Underwater Homes, Joint Debt, and Walking Away Fairly in Divorce

When a home is underwater, there's no equity to split — the question becomes how to fairly divide the shortfall and the debt.

The biggest trap: a divorce decree binds the two of you to each other, not the lender. Both remain liable on a joint mortgage until it's refinanced or paid off.

Options include a short sale, waiting for recovery, one spouse assuming it, or bringing cash to close — each with credit and tax consequences to weigh with professionals.

Most divorce-and-real-estate advice assumes there's equity to divide. But sometimes the marital home is worth less than what's owed on it, and the divorce has to split a liability instead of a windfall. It's a harder conversation — there's no pot of money to soften it — and it carries a hidden danger that catches many couples off guard. Handled honestly, though, even a no-equity home can be unwound fairly, with both people's financial futures protected. This guide walks through how.

The joint-debt trap

This is the single most important thing to understand, and the one most people get wrong: a divorce decree governs the relationship between the two spouses — it does not bind your mortgage lender. If both names are on the loan, both remain fully liable to the bank no matter what the decree says about who "gets" or "keeps" the house. A quitclaim deed transfers title but does not remove anyone from the mortgage. So if one spouse is supposed to pay and misses payments, the lender can pursue the other, and a late payment or foreclosure damages both credit reports.

The only clean ways to truly sever joint mortgage liability are to sell the home or to have the keeping spouse refinance into their own name (or obtain a formal release from the lender, which is rare). Until one of those happens, you are financially tied together — which is exactly what most divorcing couples are trying to end.

General principles only; your loan documents and decree control. Confirm with your attorney and lender.

Four ways to handle an underwater home

1. Short sale. Sell for less than the mortgage balance with the lender's approval to accept the shortfall. It severs the joint debt and ends the bleed, but requires lender cooperation, can affect credit, and any forgiven balance may have tax consequences.

2. Bring cash to close. If you have other assets, the spouses cover the gap between sale price and payoff so the home can sell conventionally and the loan is cleared. Painful, but it ends the liability cleanly.

3. One spouse keeps and assumes it. If one can refinance or assume the loan and afford the payments, they take the home and the debt — releasing the other. Hard to do while underwater, but sometimes possible.

4. Wait for recovery. The couple keeps the home (or rents it out) and continues paying together until values rise enough to sell with equity — a deferred approach that keeps them financially linked in the meantime, with all the risk that carries.

Short sales, credit, and the tax wrinkle

A short sale needs the lender's sign-off, since they're agreeing to accept less than they're owed. It can affect both spouses' credit, and there's a tax angle that surprises people: forgiven or cancelled debt can sometimes be treated as taxable income, though exclusions may apply depending on the circumstances. Foreclosure is the costlier, more damaging path that a short sale is meant to avoid, and in both New Jersey and New York it runs through the courts and can take a long time. Because the credit and tax stakes are real, a short sale is a decision to make with your attorney and a CPA, not alone.

Walking away fairly

When there's no equity, fairness means dividing the burden honestly rather than the spoils. That can mean splitting the shortfall, agreeing who covers any cash-to-close, and building in protections — like indemnification language — though such terms bind your spouse, not the bank, so they're only as good as the other person's ability to pay. The cleanest outcome is almost always to sever the joint debt as quickly as a sale or refinance allows, so neither person's credit hangs on the other's follow-through. It is not the ending anyone hoped for, but two people can still walk away clear of each other, which is the real goal.

Frequently asked questions

The Prodigy Team has handled tough, low-equity, and short sales. We'll lay out your options and coordinate with your attorney, lender, and CPA to sever the joint debt cleanly.

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Not legal, tax, or lending advice. The Prodigy Team and Anthony Licciardello are real estate professionals, not attorneys, CPAs, or mortgage lenders. Short sales, joint-mortgage liability, deficiency, cancelled-debt taxation, foreclosure, and credit consequences are complex, fact-specific, differ between New Jersey and New York, and change over time. This article is general information, not a recommendation for your situation, and does not create an attorney-client relationship. Consult a licensed family-law attorney, a CPA, and your lender before acting.

Figures and rules reflect publicly reported information current as of mid-2026 and are subject to change.