As important as dividing assets in divorce or disunion is the effective allocation of debt. No surprise is more unwelcome to a former spouse than learning that a debt assigned to the other former spouse is in default and both debtors remain liable. Equally unpleasant is when the effort to satisfy a debt is complicated by inconsistent or contradictory divorce orders that inadvertently separate control of debts from control over security for those debts. Accordingly, there are certain realities divorcing spouses must consider despite the stress associated with divorce or disunion.
Joint mortgage debt: Simply assigning responsibility for payment of the home mortgage loan in a divorce agreement or by court order does not resolve issues associated with the mortgage debt to the mortgage lender. Contrary to popular belief, the mortgage instrument and the promissory note are not overridden or voided by an order of the family court. A family court order only governs the two parties involved in the case and not creditors such as mortgage lenders who are strangers to the action. Thus, if both spouse A and spouse B have signed the promissory note, even though by court order spouse A is allocated the house and sole responsibility to pay the mortgage loan, spouse B remains obligated on the mortgage debt. Furthermore, spouse B’s obligation on the mortgage debt continues even after spouse B deeds his or her interest in the home to spouse A. How unpleasant for spouse B to be (1) unable to obtain a new mortgage loan because the home mortgage loan remains on his or her credit report and (2) facing a delinquency when the home mortgage loan is not paid by spouse A despite that spouse B has no ownership interest in the property.
Moreover, under these circumstances, spouse A’s situation is not without problems: Although spouse A holds sole title to the home and is believed to have sole responsibility for payment of the mortgage loan, Spouse B’s transfer of his or her share of the property to spouse A often will violate the mortgage conditions. Many mortgages are approved on the strength of both spouses’ incomes. Most mortgages prohibit a transfer of title of the mortgaged property without notice to, and the approval of, the mortgage lender. As a result, even though the parties are following a court order, the transfer by B to A of his or her interest in the property coupled with an assignment of responsibility to only one of the two parties will not modify the contract established between the mortgage lender and the borrower(s).
How are these complications avoided? With two simple rules:
– Do not transfer the property interest until the transferring party is released from the mortgage loan by refinance or mortgage modification;
– Have a contingency plan if the spouse primarily responsible for joint debt fails to pay.
Implementing these two steps requires careful thought and planning. For as long as the debt remains a joint obligation, the parties must have a clear understanding of how the debt will be paid and what steps are taken if there is a default.
Joint credit card debt: Similarly, credit card companies do not care how joint card holders allocate debts between them, even if a court order approves it. Rather, to the card company spouses A and B are both still jointly responsible. Thus, if spouse A agrees to be responsible for the joint VISA debt, but fails to pay, VISA is entitled to seek payment from spouse B regardless of what the court order says and even when spouse B has paid off other joint debt per their agreement. The solution here is to leave no joint debt behind. Joint credit card balances should be paid off or transferred to a new, individually held, credit card accounts. Meanwhile, credit card accounts already in only one party’s name remain solely the responsibility of that party regardless of whether the account was opened during the marriage or union.
Loans against retirement assets: What happens when one party has a debt against his or her retirement plan? If the retirement plan assets are divided between the parties, the debt must be taken into account in the division. Although the obligation to repay the debt will remain with the party who took out the loan, the reduction in value reflected by the loan can be allocated to one or divided between the parties depending on the reason the debt exists. Thus if spouses agreed to borrow against one spouse’s retirement plan to fund a child’s college education, the division of the retirement asset may acknowledge the loan as jointly incurred debt and reduce each spouse’s share accordingly. Conversely, if one spouse borrowed against a retirement plan for more singular purposes — for example to repay business debt or buy a car, the debt can be offset against that spouse’s share alone. Retirement assets must be divided carefully, with particular language and authorized by court order to preserve their tax protected status. Such orders are called Qualified Domestic Relations Orders or QDROs (pronounced “quadros”). Many retirement plans offer sample QDROs for use in dividing retirement assets, and often these sample documents will contain reference to outstanding loans with options for how such loans should be treated. In order to avoid unwelcome surprises and needless recriminations, it is important to specify what should happen to a retirement account loan and how the reduced value of the account is allocated.
Auto loans: Ordinarily, the party taking possession of a vehicle also takes responsibility for any associated vehicle loan. Complications arise when title is held jointly, when car debts are commingled, combined with a home mortgage debt or financed by a home equity loan. Again, the goal of an effective property settlement is segregating the debt, aligning it with the asset, and allocating the debt as the sole responsibility of the party who has sole control of the asset. This is not as easy as it sounds. When title to the vehicle is held by a finance company, the title cannot be transferred until it is obtained from the finance company, usually on repayment. If a vehicle debt was rolled into a home mortgage, it can prove to be a major challenge to separate the true cost of the vehicle debt from the home mortgage debt. Strikingly, a $15,000 car loan, financed over 3-5 years incurs a few thousand dollars in interest expense, but when financed over 30 years in a refinanced home mortgage increases exponentially.
School loan debt: School loan debt remains the obligation of the student. While the parties may agree to share debt associated with one party’s further education which benefitted the union, only the debtor and any co-signers will be liable to the student loan agency. Thus, a divorce or disunion agreement may designate student loan debt as a shared debt, and a court order may approve such an arrangement, but, as with mortgage loans, the relationship of the borrower with the lender remains unaltered.
Deconstructing a marriage or civil union partnership can be every bit as complex as unwinding a business. Each asset must be evaluated and each debt must be investigated. Ownership of the asset must be tied to the obligation for associated debt. If the parties are able to fully separate their assets and debts, they reduce future entanglements. If the parties cannot fully separate their debts at the point of divorce or disunion, they can develop a plan to deal with the continuing joint obligations, reduce future disagreements and unwelcome surprises.