How Debt Is Divided During a Divorce
The familiar promise that occurs in most marriage ceremonies — ’til debt, um, make that death do us part — can prompt waves of complications when there’s a divorce.
The splitting of shared assets is a priority, but what happens to the shared debt in a divorce? The bills that are routinely handled during marriage can become a contentious issue when things dissolve.
As part of the divorce judgment, the court divides the couple’s debts and assets, while deciding who is responsible for paying specific bills. Equality is the goal, but the division of assets could change that ratio. If a spouse is awarded more property, for example, that decision might be accompanied by more debt obligations for that spouse.
Each state has its own laws for dividing debts and assets. Some states consider the assets and debts each spouse brought into the marriage. Other states consider everything to be owned equally. And, of course, a prenuptial agreement will influence any decision.
Divorce: A Major Cause of Financial Stress
On a scale used by the American Institute of Stress, divorce ranks behind only the death of a spouse as a cause of stress. Financial strain invariably comes with the package.
The typical divorced person needs a 30% increase in income to maintain the same standard of living he or she had while married. That might be difficult when half (or more) of your income just walked out the door. It does help explain why divorce accounts for 8% of bankruptcies in the U.S.
Not only does a two-income household often become one, there are legal fees, division of assets, child support and alimony issues. Credit card debt can also be affected if you’re accustomed to using two incomes to pay bills charged to a credit card.
Divorce is a new financial reality, and it’s rarely as pretty as the old one. That often becomes clear soon after the judge slams down the gavel. You think you’re finally rid of your ex and the slate is wiped clean. Then you find out that he or she is stuck like a piece of gum on the bottom of your wallet.
There are varying ways each major debt can be handled in a divorce, which will be detailed in the divorce decree:
Mortgage Debt and Divorce
Typically, mortgage debt is assigned to the spouse who makes significantly more than the other spouse. Or it goes to the spouse who is awarded full custody of the children. In those cases, one party will be required to buy out the other’s equity in the home. All such complications can be avoided if the couple sells the home and splits the proceeds. This allows for a clean getaway and is usually the best strategy, even if you’re advised to keep it in place for the good of the children.
Credit Card Debt and Divorce
The responsibility of joint credit card debt can vary, but most states consider marital debt to be any debt accumulated during the partnership, regardless of whose name appears on the account. It’s likely both parties will be responsible for the debt, despite who was making the payment. If it’s a separate account, that party will likely be given full responsibility.
Medical Expenses and Divorce
In the so-called “Community Property’’ states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin), medical debt is divided, even if it means one party must take on debt they had no part in acquiring. In the “Equal Division Property’’ states, the court considers whether the couple was living together (or if there was a legal separation) when the debt was acquired, along with the potential impact the debt would have on any children.
It’s also important to know that a divorce agreement does not supersede the terms of a loan agreement.
Even if one spouse is made responsible for paying a debt following the divorce, and even if it’s a joint debt, such as a car loan, they could ignore those payments. If the other spouse is part of the loan — as a borrower or co-signer — they are on the hook for any default, late fees or collection costs.
If your name is on the loan, you are responsible — period. Lenders likely aren’t aware there was a divorce and won’t be sympathetic to anything other than repayment of the loan. It’s always best to include an indemnity clause into your divorce agreement. You could petition the court and demand that terms of the divorce agreement be followed, perhaps causing the spouse to face fines or even jail time.
Debt Management Programs and Divorce
If a couple is drowning in credit card debt and enters a joint debt management program while still married, then gets divorced before the joint DMP has run its course, there could be problems. If the two sides agree to sell possessions, the money received may be enough to pay off the debt management plan early. If not, the two sides could quit the debt management program and whatever debts are still unpaid would be divided along with the other debts.
To protect your credit after divorce, you must make sure the loans in your name are repaid. Another alternative is to have your name removed from the loan, although that’s a difficult proposition for many lenders to accept. After all, the loan was approved by considering the credit histories and incomes of both spouses, so the lender could refuse to make any concessions.
Sometimes, it’s an easier alternative to refinance. By getting a new car loan or mortgage, then using the funds to pay off the old loan, things generally are more tidy. Another effective strategy is to get separate accounts before the divorce. Separate everything on your own before the courts take that action.
Divorce and Bankruptcy
Divorce is the third leading cause of bankruptcy, which could be where one or both spouses fall if managing debt wasn’t one of the strengths of the marriage. Although bankruptcy can offer protection from creditors, it does not stop payments for court-ordered child or spousal support. It’s also a good idea to place a 100-word statement on your credit report to explain that bankruptcy was an unavoidable consequence of your divorce.
In extreme cases, when former partners become bitter enemies, there’s also the danger of identity theft. If someone — even a former spouse — has your Social Security number, birth date and other financial details, they could potentially steal your identity and cause damage to your credit score.
Avoiding debt all together is the simplest way to avoid these issues during a divorce. Granted, that’s difficult to accomplish. Having a clear picture of your assets and debts will be in everyone’s best interest. It will assure that each area is handled appropriately in court, which will help to alleviate some stress in an emotionally charged time for both people.
Get Out Of Debt Before Finalizing Your Divorce
The best strategy is to pay off debt before finalizing your divorce. That’s often not possible, however, so the obligations are split. For instance, the woman makes the car payments. The man is responsible for the mortgage payments.
Trouble begins when they either can’t or won’t pay up. Mortgage companies, credit cards and other creditors are not parties to the divorce decree. They don’t care who spent $4,392 on a post-divorce party cruise to Cozumel. They just want their money. If your name is on the account, you are on the hook regardless of what your divorce decree says.
The simple solution: Don’t have any joint accounts.
Try to close them all and refinance the house, car and other loans in one person’s name. Cancel shared credit cards and transfer the debt to cards in each person’s name.
This is where maintaining a civil relationship with your ex comes in handy. Figuratively speaking, it’s much easier to get the house in new financial order when the other inhabitant doesn’t hate your guts.
Rebuilding Credit After A Divorce
Building credit after a divorce can be difficult, especially if you are still financially linked to an irresponsible ex. You might have to work with your ex if you can’t refinance your mortgage or other major debt. Among the options are setting up a joint bank account that will allow you to monitor payments. Encourage your ex to sign up for automatic withdrawals.
The goal is to limit your exposure to potentially bad behavior by your ex. They have a lot of power, especially if they don’t mind trashing their own credit rating just to make your life miserable.
If your ex fails to pay on time, debt collection agencies can and will start bothering anyone whose name is attached to the account. You can explain the situation to the agency and the creditor, but they are under no obligation to cut you any slack.
Bankruptcies stay on your credit report for 7-10 years. You’ll have a harder time getting loans and will pay higher interest rates after you declare bankruptcy.
Nobody ever said divorce is easy. But if you have a sound financial strategy, you won’t need a stiff drink to feel it was worth it.
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