How Can Divorce Affect Your Credit?
Divorce is tough in many ways ― it can also be tough on your credit score. Going through a divorce itself will not lower your credit score since it has nothing to do with your credit history. Still, it’s a major life event where a person’s finances can get upturned for myriad reasons. And financial issues often lead to problems with your credit.
How divorce can affect your credit
Missed payments. During the divorce process, an agreement can be made regarding payments on certain financial obligations. An individual may think they’re secure, only to find out that the terms of the agreement were never followed by their ex. Lack of payments from joint accounts could be disastrous to a credit score.
Terms of separation agreements can vary by state, but more importantly, they mean little to the creditors.
“Credit issuers are not sympathetic to divorced individuals,” said Lili Vasileff, president of Wealth Protection Management in New York City. “If you are going through a divorce and your name is on joint accounts, and your ex is supposed to pay those bills but fails to do so that can absolutely affect your creditworthiness.”
Taking on too much debt. A divorce will raise the question of who will pay for the credit cards and other debt, which will typically be figured out in the settlement agreement. One person may take on most of the burden, but that can be a costly mistake.
“Sometimes people, in an effort to just be done with the process, agree to take on more of the debt,” said Patrick Beagle, owner of WealthCrest Financial Services LLC in Springfield, Va. “They don’t think of what happens to their credit score in regards to their debt-to-income ratio.”
Although carrying extra debt may be a way to save on court costs, it will make a person appear to be financially unfit to lenders if they don’t have enough income to cover it.
Mortgages and other loans with collateral. Credit cards can be divvied up, but mortgages and auto loans are not so easily dealt with. If both names are on these loans, a settlement agreement may require the loans to be refinanced into one person’s name, but the titles and deeds may still have both names. If certain fees or taxes are not paid, both parties on the title or deed may find themselves with an unpaid bill that may appear on their credit report.
Tax returns. The timing of the divorce might also affect tax filings.
“If you file a joint tax return, what if there’s a refund?” said Kathleen Grace, managing director at United Capital. “Who’s entitled to that refund? What if there’s taxes owed or an audit? Who’s responsible for that?”
These are important questions that don’t have clear answers, as every situation is different. Just be mindful that dealing with the taxman is one more financial issue that can get complicated in a divorce.
Lack of credit history. More than half of the family households in the U.S. are two-income families, according to the Bureau of Labor Statistics. However, there are still many households with only one breadwinner, and there are instances where the person without any income is financially dependent on the other.
When a divorce is finalized, the individual without any income may have to contend with having little to no credit history. For someone who was married for a long period of time, this means they may find that their credit history is no different than a teenager’s, which makes it incredibly difficult to apply for credit or loans.
How you can protect yourself
For those going through a divorce, there are ways to prevent the previously mentioned scenarios from happening.
Be proactive. Don’t wait to talk about financials until you’re served with divorce papers. In fact, discussing the financial future if something goes wrong should be talked about even before saying “I do.” It’s not romantic, but it’s important.
When the marriage begins to sour, it’s time to start working on a plan.
“If you’re contemplating divorce and things aren’t working well, start consolidating and eliminating joint accounts as much as possible,” Grace said.
This is also the time when you want to open up individuals accounts, both credit and deposit. If there is a settlement agreement that states who will pay what debt, verify these bills are being paid on time. Also, try to include language stating what will happen if debts are not paid in a timely fashion.
Check the credit report. Over the course of a marriage, couples become comfortable with sharing their information. Social security number, birth date and a fake signature are enough to add a person to a credit card, loan or another kind of debt without their knowledge or consent. After a divorce, one person may try to apply for credit and find out their name is on accounts they never knew about.
“Always run a credit report on yourself and your spouse,” Vasilef said. “I’ve had people caught completely by surprise when they found out their spouse had a new mortgage with someone else. Running credit reports at all three credit agencies is essential.”
Signing up for a credit-monitoring service is beneficial since it will keep you apprised in the event an ex decides to be vindictive and opens up accounts under your name. It’s also a good idea to change any passwords an ex may know.
Consider mediation. Divorce isn’t cheap. A survey by Nolo showed that the average divorce in the U.S. cost $15,500 with the most common hourly rate for divorce attorneys being $250. In comparison, divorce mediation can often be done for far less or even free.
“Where I see people hurt their credit more than anything is tying up a lot of funds with lawyers and costs,” Beagle said.
Instead of paying lawyers to battle in court, choosing mediation can lead to the same conclusion while saving a lot of money.
Refinance the mortgage. The person who received the house in the settlement should immediately begin the process of refinancing the home. This will not be easy as the individual will likely have less household income. But it’s best for both parties if the mortgage is in one person’s name as it will remove any legal ties from the loan as well as allow for a change on the deed for the house.
Check the small things. It’s easy to focus on the big accounts like credit cards, mortgages and other loans, but there are smaller accounts that also need to be addressed during a divorce. This includes gym memberships, cell phones and other accounts that have a contract. If these obligations go unpaid, like the other big debts, they can appear on your credit report as a derogatory mark.
Going through a divorce is not fun for anyone. It takes a toll emotionally and financially. But with proper planning, an individual can survive the ordeal with their credit intact.