Handling your debts in the divorce can break you financially if handled incorrectly. Most individuals we meet are more concerned about the asset (property) side of the equation and often overlook the liability (debt) side of the equation. Divorce settlement proceedings often break down when it comes to dividing up the debt in a fair and equitable manner. It is imperative that you have a clear understanding of what you owe individually and jointly when you start the divorce process. How you handle your debts during your divorce can make a big impact on your credit long after the two of you separated.
What Determines How Your Debts are Split?
Did you have a prenuptial agreement in affect that spells out how debts would be split? If not, you will need to consider the laws of the state that you reside in for dividing your debts and assets. Certain states will consider which assets and debts each of the parties brought into the marriage and which assets and debts they took on during the marriage. If you live in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin), everything that is acquired or owed during the marriage is considered equal. That means if your spouse took on a credit card without your knowledge, you would still be liable for paying that credit card even though your name is not on the account.
How Much Do I Owe? (Individually and jointly)
The first step you should take to protect your credit and to understand what you owe is to pull your credit report from the credit reporting agencies. You have the ability to pull one free credit report per year from each of the three major credit reporting companies. You can obtain the report from the following links: Experian, TransUnion, and Equifax. Take the time to review your credit report. For inactive accounts (zero balances) that are jointly listed, consider closing these accounts to eliminate the risk of creating additional debt that you could be liable for. For accounts that you are listed as the account owner and have your spouse listed as an authorized user, have the spouse removed as an authorized user. You should communicate these actions to your spouse for a number of reasons.
How Do I Handle Joint Debts?
When you are married and you apply for credit together, each of you is agreeing that you are responsible for that debt. While splitting debt in your divorce decree is part of a settlement process, the credit companies are not bound by the divorce decree and still view the debt as jointly owned. For example, if you have 2 credit cards (Visa owed $1,000, MasterCard owed $1,000) that you split during your divorce, you agree to pay off Visa for $1,000 and your spouse agrees to pay off MasterCard for $1,000. Six months after the divorce, you ex-spouse stops paying the MasterCard, you would be liable for the remaining balance. You attorney will probably advise you to have an indemnity clause in your decree if either spouse defaults on joint debt. However, this only gives you the right to go after your ex-spouse for the amount owed (usually through court) which will cost more money. Plus, the indemnity clause is not binding to third parties like the credit card company. It is best to get rid of joint debts prior to the divorce. If you agree to split a jointly owed debt, make sure that the payments are being made in a timely manner or your credit score is going to take a hit. If the payments are not being made, make the payments and keep a record so that you can get these payments back from your ex-spouse through the indemnity clause.
Strategies for Splitting Joint Debt
As you can see from the example above, this scenario can turn into a nightmare. If you have an account that goes into default, you have the potential of having your credit score impacted negatively for up to seven years! We advise our clients that have joint accounts to ask the creditor to convert the accounts to individual accounts. Most companies will not do this and will require you to apply for credit individually. Once you have been approved, you would then split the joint debt by moving it to your new accounts and closing the joint account. If you can’t get credit through conventional sources, you may have to ask family members or even employers to help you out with some short term financing.
Divorce and Bankruptcy
If you have concerns that your ex-spouse may be filing for bankruptcy, you will want to structure your property settlement in a lump-sum agreement if possible. Also, if payments are to be made over a period of time, you may want to have those payments classified as child support or alimony. This can help in protecting you from losing the income in the bankruptcy. Additionally, any joint debt should be split into separate debt where feasible. What this means is, if you have joint credit cards, these open joint credit accounts will be listed in the bankruptcy and will have a negative impact on your ability to get credit in the future. See our Divorce and Bankruptcy article for more information.
For more advice related to handling your debts in divorce, download our ebook: The Financial Divorce, Your Guide To Financial Divorce Knowledge.
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