Avoid credit and debt disaster during divorce
By Miranda Marquit
July 29, 2015
If not handled correctly during a divorce, commingled debt can haunt your credit records for years after the papers are signed. But if you understand a few facts about divorce and debt, you can avoid credit disaster.
Here’s what you need to know about disentangling your finances when your marriage ends:
If you suspect you’re headed for divorce
Understanding the basics of divorce and debt can help you prepare for the dissolution of your marriage.
If you think you’re on the road to divorce, you should start separating your finances as soon as possible, says Emma Johnson, the financial expert behind the site WealthySingleMommy.com and the nationally syndicated radio show “Like a Mother.” Pay off and close joint accounts before heading to court.
Community property and your debt
While it may seem that if your partner incurred debt, he or she should be responsible for the full bill, that is not necessarily the case.
“If you are in a community property state, you are responsible for any debt acquired during a marriage,” says Johnson. “This is true whether or not your name is on the debt or whether it is fair.”
“If you are in a community property state, you are responsible for any debt acquired during a marriage. This is true whether or not your name is on the debt or whether it is fair.”
— Emma Johnson,
Tess M. Reutzel, an attorney specializing in divorce, says that a community property state is any state that insists that any property — or debt — acquired by either partner during a marriage belongs to both.
“Any debt incurred between the date of the marriage and the date of separation is considered community property and will be divided equally,” she says. State laws differ slightly on the definition of community property, however, including rules that could warrant an uneven distribution of debt for reasons such as “marital waste” or hiding assets.
Community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Alaska is a special case that gives couples the option to decide which property they would like to be held in common. In non-community property states, assets and liabilities acquired during the marriage are often split evenly among the partners during a divorce.
“Many times, clients discover that their spouse has acquired credit card debt without their knowledge during the marriage,” Reutzel says. “Those clients are often surprised to hear that they can still be held responsible for the debt. There are only a few exceptions to this, such as when the other spouse incurred debt for non-community purposes or breached fiduciary duties to their spouse.”
For couples who don’t live in community property states, what happens with the debt most often depends on whose name is listed as a responsible party.
Joint debt vs. individual debt
In non-community property states, you are on the hook only for debt that your name is attached to, says Johnson.
If your soon-to-be-ex spouse opens a secret credit card account, and you live in a non-community property state, you shouldn’t be responsible for that debt, since your name isn’t associated with the account.
On the other hand, if the debt is jointly held, you should be equally responsible for repayment. In the eyes of a card issuer, a joint card means that both spouses are liable for any balance, even if one spouse never used the card.
“Many times, clients discover that their spouse has acquired credit card debt without their knowledge during the marriage. Those clients are often surprised to hear that they can still be held responsible for the debt.”
— Tess M. Reutzel,
specializing in divorce
Court orders don’t trump credit agreements
“Spouses can decide to divide their debt in any way they choose,” says Reutzel. “If one spouse takes more property, they may also take more of the debt to equalize the division of the community estate.”
For example, a spouse might take on $10,000 in credit card debt as part of an agreement that allows that spouse to keep a paid-off car worth $10,000.
Similar arrangements can be made with homes. If one partner wants to retain the house, he can do so, with the understanding that the mortgage is transferred to his name. In some cases, if there is equity in the home, the spouse retaining the house buys out the other.
However, even if a particular division of debt is ordered by a judge and all parties sign the agreement, that doesn’t mean that creditors are bound by the document.
“Watch out for jointly titled debt,” says Reutzel. A creditor can come after you for payment of a joint debt, no matter what the divorce settlement says.
Reutzel and Johnson suggest insisting on having any debt refinanced in the name of the spouse who is responsible for that particular debt.
“It is not enough to have your name removed from an existing loan,” Johnson says. “Identify which debts your spouse is ordered to pay and insist in the divorce negotiations that any outstanding balance be refinanced in his or her name.”
Advice for the engaged and newlywed
If you aren’t yet married, Reutzel suggests that you can protect yourself with a prenuptial agreement.
“A document can be filed with the county recorder’s office to provide all third parties with notice that you have a prenuptial agreement that impacts a creditor’s methods of enforcement,” she says.
The best option, though, is to try to remain open about finances throughout the marriage, and to keep debt separate as much as possible. As each spouse builds an independent credit history, there is more protection for both down the road.
SEE RELATED: 8 ways to rebuild your credit after a divorce