One often extremely challenging issue in divorce is figuring out a way to fairly divide any accumulated debt as well as what to do with assets that have outstanding loans held in joint name. The divorce judgment is binding against the couple getting divorced but since the creditor is not part of the case, the terms of the Judgment do not apply to the creditor. The parties can agree to assign a debt to one spouse but if it is a joint debt the creditor can continue to come after both parties to collect on the debt. This week’s blog focuses on different ways we deal with debt, and especially joint debt in divorce to ultimately accomplish a complete untangling of obligations so that moving forward so that one spouse no longer remains liable for the actions of the other spouse.
It is very common for there to be issues of joint debt at the time of divorce. Couples may have jointly held credit cards, home mortgages, car loans, and many other liabilities for which they are both contractually bound to the creditor. So how do we deal with this situation where the couple is looking to go their separate ways but are extremely tangled in liability? The easiest way is to use assets to pay off all the debt if this is an option. More often it is not and the next option is to have each spouse take steps to transfer the liability solely into their own name. This can sometimes be challenging as well in which case the third option might be selling the asset to eliminate the debt. Finally, a fourth option might be assigning the asset to one party but continuing to have the debt held in joint name with certain safeguards to minimize the risk to the other spouse. The goal is to provide for each spouse to move forward after divorce completely independent of one another but there can be a number of challenges in accomplishing this feat.
Pay off all the Debt. The easiest way to untangle the liability of the couple is to pay off all the debt. This might be an easy thing to accomplish if the couple primarily has credit card debt. It is less likely when there are bigger ticket items with large loan balances such as houses and cars. Divorce can often be a time of financial uncertainty and the finances of the couple can be extremely tight so using savings to pay off debt may not even be an option and if it is, cutting into the savings buffer may not be the ideal way to proceed. Paying off joint debt and either removing the other spouse or closing out the debt assures that one spouse cannot be held responsible for the spending of the other. This is the end goal of the divorce so if there is a way to get things paid off this is what we are shooting for.
Transferring the Liability into one Name. More often couples are not in a place at time of divorce to get all the debts paid off so the next best option is to transfer the debt so it is held in the name of the spouse assuming the responsibility. For credit cards this is usually accomplished by transferring the portion assigned to each spouse from the joint card to a card held solely by each spouse. For a bigger item, such as a house, it involves the party receiving the house proceeding with a refinance of the loan to have the other spouse removed. When this is done the spouse receiving the house often will take out funds along with the refinance to buy the other spouse out of the asset. Vehicle loans and leases are dealt with similarly. Being able to qualify for a new loan may pose a challenge. Sometimes these loans are taken out jointly because the consideration of the incomes of both spouses are necessary to have sufficient income to qualify for the loan. If one spouse has less than stellar credit they may not be able to accomplish taking out a new loan or refinancing. There are circumstances where a lender will allow one spouse to assume the loan responsibility and have the other spouse removed from the liability but this is usually more the exception than the rule.
Selling the Asset. It is usually the policy of the Court that if one spouse wants to keep an asset that has joint liability, they are required to have the other spouse removed from the liability in order to keep the asset. If this can’t be done and there is no agreement to proceed in another creative way, then the asset must be sold. With interest rates on the rise I am seeing more couples in a position where neither is able to qualify for the loan to refinance the existing debt and get the other spouse their portion of the equity. Instead of refinancing, the asset is sold and the proceeds divided appropriately between the parties. There might be costs associated with the sell such as Realtor and closing costs related to the sell of a house, so it is usually more desirable for one spouse to buy the other out, but if the financial picture does not make it realistic to do so, selling the asset is often the necessary outcome.
Getting Creative with Joint Debt Couples can agree to get creative with joint debt. The Court will accept agreements that might assign a joint debt to one spouse who takes responsibility for the debt while the other spouse remains contractually liable for it. As mentioned, these agreements bind the spouses but do not limit the creditor’s rights to come after both parties. If the spouse who has been assigned the debt fails to make payment, the other spouse can have their credit negatively impacted and the creditor can seek to collect for both. One option is to have a defend and hold harmless provision which allows the other spouse to seek reimbursement from the spouse who was assigned the debt for any amounts they are forced to pay on the debt, and any other expenses incurred. This is less than ideal and doesn’t protect the credit of the other spouse. For secured loans there might be agreement that the other spouse will remain on the loan until such time as they decide it is no longer acceptable in which case notice is given and the spouse who received the asset has a set period of time to get the other spouse removed from the liability. There might also be provisions that the spouse receiving the asset is required to make timely payment and if any payment becomes over 30 days past due then an immediate refinance is required or the asset must be sold. Given that many divorcing couples have home loans that were secured when rates were much lower, there is incentive to find creative ways to not have to refinance at a higher rate. The drawback to these creative options is that the endgame of complete untangling has not been accomplished. Couples must consider this drawback as they work together to find the best way to proceed.
Sorting out debt issues in divorce can be a very important and challenging part of the divorce process. The strain of debt on the family might be one of the factors that contributed to the breakdown of the marriage. Moving from taking the combined resources of the family to manage one household and now needing to manage two exacerbates the financial situation of the family so there is typically a much greater challenge to manage the debt load of the couple. While getting rid of the debt is the most desirable outcome, the circumstances of the family dictate which options make the most sense with the goal to allow each spouse to move on independently responsible for managing their own financial responsibilities. Exploring all the options is essential to accomplish the best outcome.