If splitting “fun” things like investment accounts and collectibles is painful in a divorce, what happens when you get to dividing something neither spouse wants?
Welcome to dealing with family debt. Virtually every divorce negotiation must address this at some point because most Americans have at least some debt. And yet, many couples arrive to this juncture unprepared and confused.
Here’s what you need to know.
Debt Division 101
Texas is a community property state. That makes things complicated.
The specifics of YOUR situation will drive the division. There is no one-size-fits-all solution. You might both be equally responsible for portions of the debt, or just one of you might be responsible. Dividing debts in a divorce is more complicated than you might think. This is not a do-it-yourself project.
I may not have the ready-made answers, but I can give you three questions that will set you on the right path. Hopefully this will save you a lot of time, money, and headache in the long run.
- Is the debt in question community property or separate property? If you don’t know the answer or aren’t 100% sure, ask your collaborative family law attorney.
- Should the debt be examined by a forensic CPA? In some situations, your attorney may recommend hiring a forensic CPA to determine whether it belongs in the “community property” bucket or the “separate property” bucket.
- Have you exhausted your research options to ensure that you have your arms around the full universe of debt? Many people going through a divorce are not aware of some of the debts.
Best practices for dividing debt in a divorce
Step one: Start with a full list. This may sound obvious but getting to a complete inventory of all debt can take time and effort. Do your research. Carefully review each of your recent credit reports. Go through the bank statements to make a list of all debts with recent payments. Debt comes in all shapes and sizes, from mortgage to car leases, credit cards, medical bills, tax bills, etc. There is a possibility that you may not know about some of the debt, so look carefully and question any transactions you don’t recognize.
Step two: Get clear on your goal. In the best-case scenario, you goal should be “no shared debt after divorce”. That means no credit cards or loans with both names.
Many couples resist this, especially if the divorce is relatively amicable. I get it. It’s easier to just agree that ex-wife will make payments on the shared credit card debt until the debt is fully paid up, or that ex-husband will make car payments. Leaving a few things “as they were” can feel comforting in this time of chaos.
However, that arrangement makes you exposed to financial risk in the future. Remember that creditors don’t care what your divorce agreement says. They just want the money. If your ex-spouse decides that car payments are no longer in the budget (or transfers additional debt onto the shared credit card, then stops making payments), you will be left holding the bag. Yes, financial issues in divorce are complex and sticky.
Your options by type of debt
Your choices for moving forward will depend on the specific mix of debts you hold at the time of the divorce. Here are some notes by category.
- Credit card debt: Ideally, you want to pay off the debt on shared cards then close the accounts. An open card in both names leaves you exposed, potentially for years after your divorce is final. It can compromise your credit history, ruin your chances for a promotion or a new job (if your job relies on your credit), and cost you tens of thousands of dollars in payments and fees.
- Mortgage: Your options are to either sell the home and settle the debt with the proceeds, or to buy your spouse’s ownership share of the house. Remember that you may need to get the home re-financed in just your name. It’s very important to fully explore and understand the consequences of keeping the home to be sure that you will be able to qualify for a mortgage and handle the payments. Either way, make sure that the other spouse’s name gets removed from all property documents. Both your attorney and your divorce financial planner can help you fully understand the nuances of your options.
- Car loan: Here too, consider refinancing the car in just one spouse’s name. Take an honest look at your post-divorce budget, especially if the car in question is a luxury/newer vehicle with high monthly payments. Consider whether you need to keep the same car. Would it make more financial sense to transition to something that won’t punch a hole through your cashflow while you are getting back on your feet?
- Medical bills: In a community property state, you may be responsible for your spouse’s medical debt. You will need a plan here much as you do for other kinds of debt. If your ex-spouse takes over paying off old medical bills after divorce, talk to your attorney to determine whether you could be held responsible for this debt. If so, consider getting a life insurance policy that could cover the payments in the event of your ex-spouse’s death. Ask your attorney and your divorce financial planner about whether you should consider taking out disability insurance for your ex-spouse to protect yourself financially.
Debt and divorce: you need a plan!
Dividing debt in a divorce can get complicated. You must face what’s there. Many couples don’t realize how bad their debt situation is. Some think that $50,000 in credit card debt is a perfectly normal way to manage finances. Brace for surprises: there’s a chance that your soon-to-be-ex may have run up some balances without telling you. Expect to lean on your professional team, including a family law attorney and a financial planner. Do not try to sort this out on your own. And remember, debt division isn’t over till it’s over. After your divorce is final, be sure to double-check all accounts and your credit history. You deserve the cleanest new start. Getting clear of shared debt is an important part of moving forward.