Question of the Week Week of Dec 16, 2013

Divorce and Credit Card Debt: Who Owes What?

Divorce-and-Credit-Card-Debt-Who-Owes-WhatWant to complicate an already complicated situation?  Mix credit card debt with a failing relationship.  Unfortunately, figuring out what happens to credit card debt in a divorce is an all-too-common predicament for the contemporary consumer, as divorce rates continue to hover around 40% and the average household owes well over $6,000 to credit card companies.

Understanding how to approach credit-related debt once the divorce papers have been filed (or even during a separation) is therefore a must.  And since the particular dynamics and solutions that are in play are largely situation-specific, you should choose the link below that is most applicable to your own circumstances in order to garner the most pertinent advice.

  1. You & Your Spouse Have Individual Accounts
  2. Shared Credit Card Accounts

Individual Credit Card Accounts & Divorce

If you and your spouse only have credit cards in your own names, your divorce will have absolutely no direct impact on these accounts.  You applied for the cards as individuals and you’re responsible for them as individuals, regardless of whether or not you’re married.

However, the fact that regulations enable consumers to garner approval for individual credit cards by listing shared income on their applications does complicate things a bit.  If, for example, your spending limit is largely a product of your partner’s earning power and your bank does not reduce it following the divorce, you could conceivably get yourself into some serious trouble by racking up a bunch of charges that you can’t afford to pay off.  Understanding the potential for that to happen and taking certain precautions – such as establishing a strict budget, setting up automatic monthly payments from a bank account, and using a credit card calculator to mitigate interest – should enable you to avert such a crisis, though.

It’s interesting to note that the use of household income on credit card applications was initially banned by the Credit CARD Act of 2009, but public outcry (largely from women’s groups concerned about what the change would mean for stay-at-home parents) quickly led to a reversal by the Consumer Financial Protection Bureau.

Shared Credit Card Accounts & Divorce

Anything that is shared can become a point of contention during divorce proceedings, and credit cards are no exception.  A legal obligation to pay for any balances that are ultimately incurred accompanies credit card use, after all, and it applies anytime your name is listed as one of the primary accountholders.  Shared accounts also impact the credit standing of both users.

“There is no ‘divorce’ variable in the report – so the [credit] score is not formulaically impacted,” says J. Michael Collins, faculty director of the Center for Financial Security at the University of Wisconsin, Madison. “But pulling apart income, liabilities, and debts can change debt utilization ratios, ages of accounts and other items that will impact scores. Bankruptcy – which one or the other ex-spouse might pursue – will have a starkly negative impact for several years.”

With that said, the issues related to shared accounts and divorce depend on the type of account in question as well as whether or not there is an outstanding balance.

When There is Zero Balance…

If a shared account does not have an unpaid balance at the time of your divorce, simply closing it will prevent any further strife.  Either you or your spouse will be able to close a joint account or an account opened with one of you as a co-signer.  On the other hand, only the primary accountholder can an account that has an authorized user.

When an Unpaid Balance Exists…

There are three things that you need to remember when dealing with a shared credit card that has an existing balance:  1) Credit card companies just want to get paid, and they don’t care by whom; 2) Card issuers aren’t beholden to divorce agreements; and 3) The payment process waits for no one.

“Bottom line, a divorce court or divorce agreement may determine obligations of spouses toward each other regarding joint debts, but not creditor’s rights regarding collection from debtor spouses,” says Marsha Garrison, a professor at Brooklyn Law School and expert on family law. “Thus, failure of a spouse named in a divorce order as obligor can affect the credit rating of the other spouse, lead to collection proceedings against that spouse, etc.”

What does that mean for divorcees who are in the hole to a bank for unpaid credit card charges?  Well, it means that you need to quickly figure out payment amongst yourselves or risk incurring substantial interest charges and credit score damage.

That may seem like an insurmountable task if you and your ex aren’t on the best of terms, but we have a few tips that may help:

  • Chop the Pot & Transfer Balances:  Perhaps the fairest solution to shared credit card debt during divorce (without court involvement) is to split the amount owed proportionately based on each party’s income.  The best way to execute this strategy is for each party to transfer their respective balance to their own individual credit card before closing the original account.  There are usually at least a few balance transfer cards offering 0% interest for the first 6-24 months, which means that you could even save money with this arrangement.
  • Be the Bigger Person:  If you’re unable to agree on who owes what to a credit card company during a divorce, one person or the other might just have to step up and pay the full amount.  You might consider this to be a costly and unnecessary concession (and you’re probably right), but it’s preferable to missing payments, incurring credit score damage, and seeing your balance grow as finance charges are applied while you bicker over whose turn it is to pay even the minimum required each month.
  • Remove an Authorized User:  Many families have one central credit card for which the primary breadwinner applied before giving his or her significant other access to it as an authorized user.  Simply removing said authorized user from the account will prevent them from racking up further charges, but it won’t affect any existing balances.  You’ll unfortunately just have to suck it up and pay those off even if the authorized user made the corresponding purchases because you alone are responsible for account activity.

Bottom Line

A couple who is going through a separation or divorce has far better things to worry about than who gets the credit card debt.  Unfortunately, this can become a major point of contention when a substantial balance remains.  Communication is essential to resolving such a situation with minimal credit score damage and finance charges incurred, as creditors just want their money regardless of where it comes from and aren’t even bound by divorce mediation or court rulings.

Why is that? According to Lynn Wardle, a professor at BYU Law and an expert in family law, it’s “because (a) the Constitution protects against the ‘impairment of contracts’ such as the contract between the credit card company and the borrowers, and (b) additionally, the credit card companies usually are not parties to the divorce action and it would deny them due process to take their valuable financial rights in those circumstances.”

The ideal resolution would entail each party submitting a payment for a portion of the balance (directly, or indirectly through a balance transfer) in accordance with their income levels.  Things clearly don’t always go according to plan, however, which means you may need to move quickly to close zero balance or low balance accounts, remove authorized users, or leverage credit line decreases to reduce spending power.

At the end of the day, just remember that your financial standing is the priority here, not your ego.  Placing emphasis on the latter may end up costing you in terms of both finance charges and credit score damage.