This is a guest post by Tim Chen who is the is founder and CEO of NerdWallet.com, a website that helps consumers to compare credit card offers. Tim also educates consumers about credit cards and debt management at the Forbes Moneybuilder Blog, the Huffington Post, and U.S.News.
The Golden Rule: If your name is on a contract with a creditor, no court order can negate your liability.
If your former partner stops paying a bill with your name attached to it, even if a court decided that the liability or loan belongs solely to the ex-spouse, you will start getting calls from the collection agency. Therefore, it’s wise to divide all loans and financial contracts so that they fall under only one person’s name. This includes auto loans, home mortgages, credit cards, and insurance policies.
If you’re going through a divorce, there are certainly a lot of financial considerations to address. One of the most important of these is your credit. As you begin to establish a new life you will need a favorable credit score to rent an apartment, start bank accounts, apply for a credit card and possibly even get a job. Here are a few financial pitfalls to be aware of before signing the final papers.
Lack of Credit
If you’re a stay at home parent, you may think you have very little or no credit but that is most likely not true. If you opened a joint credit card, mortgage or other loan, it is not only on your spouse’s credit report but also on yours. Providing you have a stellar payment history, these loans should not have had a negative impact on your credit score. In fact, you should have a favorable FICO score. If you do have a limited credit history, opening a low limit credit card or secured credit card account should set you on the right path.
Although your credit score may have been close to perfect, the divorce could cause some damage. One way this will happen is in your debt utilization. As a married adult, you most likely have or had credit cards and other loans that gave you a total amount of available credit (like a home equity line or a credit card limit). If those joint accounts will be cancelled upon divorce, the amount of available credit you have will go down and whatever part of the balance you have to pay will have to be moved to a new credit card or home equity line. This means your debt stays in place, but your available credit goes down. Increasing your utilization ratio like this can have a substantial negative impact on your credit rating.
The best way to avoid this is to agree to pay off joint debts before divorce. Of course that isn’t always possible, so the next best option is to divide up accounts in such a way that each partner has a fair share of the total debt to deal with after the divorce, potentially even using balance transfer credit cards to divide loan balances onto new non-joint cards.
Trusting your Spouse
Most divorces aren’t as heated as the drama-filled episodes we see on TV. In fact, many people work out terms that give both parties some leeway in getting all of their financial affairs in order. But be careful of any arrangements that don’t sever all ties completely.
Imagine this scenario: Mike and Molly have decided to divorce and instead of selling the home and splitting the profits, Molly is purchasing the home from Mike. They work out a deal where within 6 months Molly will refinance the home and pay Mike. During that time, Molly is paying 100% of the mortgage.
Four months later Mike tries to take out a loan and finds his credit ruined. Why? Molly wasn’t able to pay the mortgage and now Mike’s on the hook! Remember that although you used to be married to this person, you are about to be your own person. Would you trust anybody else with your credit?
To avoid problems like this, break all financial ties when the divorce papers are signed. Don’t trust your soon-to-be-ex (or anyone else) with your financial health. Divorce has the potential to do damage to your credit and financial well-being, but with some awareness and smart financial planning, you can lessen the negative effects considerably.