Ask John: Divorce and Credit

The Impact of Divorce on Your Credit

Background

Please meet Kate, a 27-year-old mother of two children who lives in Montgomery, Alabama. Last May, Kate and her husband of six years divorced and went their separate ways. Up until a few months ago, she had a very good job as a customer service agent for a regional bank.

Kate, just like many single mothers, depends on not only her income but also child support payments in order to make ends meet. She has established credit in her name and hopes to buy a home in the next year after she can save enough for a down payment.

Kate’s Dilemma

In what can only be described as Murphy’s Law, Kate and her ex-husband both lost their jobs within weeks of each other. In less than one month, Kate’s income and child support payments were gone.

Kate’s ex-husband is a good person and he tries to scratch together the $800 that he has to pay in child support each month. Unfortunately, he isn’t making the full payment and is also letting other credit obligations go delinquent as well.

For the next several months, it’s a struggle for Kate. But, she works hard to adjust her expenses and eventually things seem like they are getting better. She lands a new job as a Member Services representative at a local credit union and is actually making a better income than at her old job. Her ex-husband is still not making the full payment each month but is becoming more consistent with the payments he is making.

Then it happens. Kate starts getting calls from collection agencies trying to collect on accounts that she thought were the responsibility of her ex-husband. She tries to explain to the collectors, “the judge said that my ex-husband is supposed to pay that bill,” but they keep on calling demanding payment.

Kate knows that this is simply an error and that when the divorce was finalized she and her ex-husband went their separate ways. Their credit was divided by court order and that was that…or so she thought. Kate is now learning the hard way what tens of thousands of other divorcees already know: court orders do not negate the original contracts with your creditors.

This means that regardless of what the court says, if you signed a contract to be responsible for payment on any type of credit (home loan, car loan, credit cards, etc.), then you are still legally responsible for making sure that the payment is being made. And, if the payments stop, then the lenders can pursue you as well as any other party that signed for the credit. And, lenders can also report the delinquent accounts on both parties’ credit reports. This is all perfectly legal and happens every day.

The problem was that Kate’s ex-husband was trying to balance the little income that he had between child support payments and credit accounts that were his to pay according to the court. He was unable to keep up with both so the lenders starting sending the accounts to collection agencies.

The effect this is having on Kate is nothing short of catastrophic. Her credit scores are dropping each month as more and more late payments pile up. Her goal of buying a home for her and her children is in serious jeopardy. In fact, Kate is now thinking of filing for bankruptcy in order to get out of debt. Doing so will essentially sink her credit scores for up to 10 years. That’s right, 10 years. That’s how long most bankruptcies will remain on your credit reports.

Kate’s Options

Kate has several options on how to address this situation. They are:

• She can use the money that she has saved up for her house down payment and begin making payments on accounts that are supposed to be paid by her ex-husband. This will save her credit scores but will wipe out her savings and any chance she has to buy a home for the next few years. Plus, Kate is hesitant to bail her ex-husband out given the fact that…well, he’s her ex-husband.
• She can contact each of her lenders and inform them that the account has been assigned by the court to her ex-husband. While this seems like the right way to have them redirect their collection efforts, it’s unlikely that they will stop harassing her. The purpose is to show a good faith effort of working with her lenders, a fact that won’t go unnoticed should Kate ever end up in a courtroom again because of the delinquent payments.
• If the creditor will allow it, convert the account to interest only for a short period of time. This will lower the payment and perhaps make it easier for the ex-husband to make payments. Once he’s back on his feet, the accounts can be converted back to interest plus principle.
• If her ex-husband is willing, roll all the outstanding balances into new credit cards, car loans, etc. This will take a joint account and turn it into an individual account in his name only. This will have the same legal effect as the court order. It will make him solely responsible for payment on the account and get Kate off the hook for good.

The Best Course of Action

If you listed the top “life events” that can seriously damage a person’s credit and credit scores it would look something like this.

• Loss of job
• Divorce
• Death in family
• Medical emergency

All of these events have one common denominator, the loss of funds required to keep up with minimum credit payments. Once those payments begin going delinquent, your credit scores will begin to fall.

Kate is in a difficult position here. On one hand, she really doesn’t want to bail out her ex-husband by dipping into her savings. On the other, however, she also doesn’t want bad credit to ruin her life for the next 10 years either.

Kate needs to be practical regardless of what her emotions are telling her. Her decision should be to dip into her savings and pick up on making the payments so that her credit scores don’t suffer for years to come. If that means that she has to completely pay off accounts that her ex-husband is supposed to pay, then so be it.

This will sting a bit, but when she gets approved for her new home loan and fills the garage with a new car, (both financed at a very competitive 6% interest rate), she’ll be glad that she did it.

If she had chosen to go down with the ship, then she and her family would have had to wait for many years before her credit was good enough to buy anything at decent rates.

It Would Have Been Nice If

In this case hindsight is 20/20. If Kate knew of the impact that divorce can have on credit reports and credit scores then it would be much easier to prevent this type of situation from ever occurring. Here is what she could have done.

• The first thing she could have done would be to close all of their credit card accounts and use family funds to pay them off. This prevents either the husband or wife from abusing the remaining credit limits. New credit could easily be established in each party’s name, individually. That way there is no confusion over who is supposed to pay what.
• Refinance the auto loans so that one person owns the car. Essentially one of the two spouses would be buying the car from the other. This way it’s in one person’s name. If they stop making the payment, then it only hurts their credit, not both spouses.
• If the house is in both spouse’s names then sell it. That’s right, you’Ave got to sell the house. You can sell it to someone you don’t know, or, one spouse can sell it to the other, (assuming that one income is enough to qualify for the loan). This way you are both getting the equity out of the house, which can be split or used to pay off other loans. Again, the mortgage account is in one person’s name so if they stop making payments it only hurts their credit.
• Consumer Credit Counseling Service can assist with a Debt Management Program for fulks who are going through a divorce. They are a non-profit organization and are very good at what they do. If you feel like you need help then you should contact your local CCCS office.

Summary

The reality is that divorces are unpleasant and frequently involve ugly legal battles where only the lawyers win. It’s very common that the credit reports of both spouses become trashed with late payments, collections, judgments and bankruptcies. This doesn’t have to happen but it will take some effort on behalf of both parties to avoid it.

Kate has plans for her and her children. She wants to get a house in a nice neighborhood and move on after her divorce. If she wants to do this she’ll need a good credit report with solid credit scores. Otherwise her divorce will linger on for years in the form of credit declines and higher interest rates.

We wish her the best.

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