Debt is one of the leading causes of divorce, and one study showed that couples who routinely fight about money are more likely to separate. At David Sklar & Associates, we often work with clients dealing with both divorce and financial problems at the same time, wondering what happens to debt in a Divorce.
Couples struggling financially face an uphill battle when filing for divorce. The divorce process entails paying legal expenses, which can be rather pricey. Each partner faces higher living costs as they can no longer share expenses. And if significant debt is involved, determining who’s responsible for it can be challenging, sometimes leading to fierce arguments.
Divorce proceedings can be even more complicated if significant debt is involved. In this article, we’ll examine how debts are split in a divorce, who’s responsible for paying what, and your options for dealing with debts you cannot afford.
Who’s responsible for debt after a divorce, and how is it divided?
Being married doesn’t make you automatically responsible for your partner’s debts and vice versa. In much the same way, creditors won’t necessarily pursue you for payment if you’re going through a divorce.
From the creditor’s perspective, relationship status is irrelevant. In their eyes, responsibility for repaying a debt belongs solely to the person or persons who signed the agreement. In the case of the Canada Revenue Agency (CRA), tax debt is traced to a particular taxpayer.
In determining whether you’re liable for a debt, it’s essential to understand the difference between individual and joint debt.
Individual debts
An individual debt is one in which only one person has taken out the debt and signed the contract.
For example, if you applied for a credit card independent of your spouse, the agreement is strictly between you and the lender. While you may allow your spouse to charge purchases to the card, only you bear responsibility for paying the balance. If you default on your loan, the lender has the right to pursue legal action against you, not your spouse. This rule applies to debts acquired before and during your marriage.
In addition, any late or missed payments will negatively impact only your credit score, as you own the debt.
Joint Debts
A joint debt is one where two or more people apply for and sign a loan agreement.
If you share a joint debt with your spouse, the creditor will hold the two of you equally responsible for payments until the debt is paid in full. This obligation applies to all joint debts: mortgage, line of credit, credit card, car loan, etc. Should the debt go into default, the lender can take measures to recover the balance owing, including filing a lawsuit, freezing your joint bank account, or sending the account to a collection agency.
Remember: when it comes to jointly held debt, you’re obligated to repay the entire balance. Do not believe in the myth that two people are responsible for the joint debt on a 50/50 basis. If one borrower doesn’t pay their share, the other is still responsible for 100% of the amount owing to the creditor.
Co-responsibility for debt also arises in cases where one spouse co-signs or guarantees a loan agreement. It doesn’t matter if you never applied for the loan in the first place – as long as you add your signature to the contract, you’re jointly liable for the entire balance. Thus, if your spouse fails to make timely payments, the creditors will demand that you step in and cover them.
Can you create a custom debt repayment plan with your ex-spouse?
The short answer is “yes.” You and your ex-spouse can create a plan for resolving outstanding debts upon separation or divorce. For example, you may decide to each contribute 50% of payments to settle joint debts. Or you may agree to assume full responsibility for your spouse’s personal debts, such as an unpaid credit card balance.
However, it’s crucial to understand that a private agreement with your ex-spouse doesn’t change anything from the creditors’ perspective. The reason is informal debt repayment agreements you make with your partner are not legally binding upon creditors. While your creditors will happily accept payment from anyone, they’ll pursue only the original borrower listed on the loan contract in case of a past-due balance.
So, if your ex offers to pay off your personal credit card balance but subsequently fails, the lender will only take action against you to recover the money. Similarly, creditors can equally chase you or your ex for 100% of past-due payments on joint debts, regardless of how you personally divide payment obligations.
If there are joint debts and your former partner files bankruptcy or a consumer proposal, you’ll be accountable for the entire unpaid balance.
Given the trouble that joint debts can pose, it’s wise for you and your spouse to exercise good faith and cease any further borrowing from joint accounts during the divorce process. Consider reviewing your credit report to identify joint debts you share with your partner so you can formulate a plan for dealing with them.
How does the court decide how to split up debts?
Ideally, you and your spouse will decide how to divide debt obligations in a manner that’s fair and reasonable. But if that’s not possible, the court will get involved to resolve the dispute.
Family debts are debts you or your spouse entered during your marriage. These can include mortgages, credit cards, overdrafts, lines of credit, and loans from family members. Like family assets obtained during marriage, the court will typically split family debt obligations equally between you and your ex-spouse. In other words, debt acquired during the marriage is considered joint debt by the court.
So, if your spouse brought student loan debt into the marriage, you won’t be legally responsible for repaying half of it. But you could be obligated for student loan debt they incurred after you got married.
However, there are instances where the court will split debts unequally. In such cases, the judge will base their decision on several different factors, including:
- The ability of each spouse to manage their share of the debt
- How the debt came about
- The length of the marriage
- Whether the value of the debt exceeds the value of the property
- Whether there exist any agreements (signed and witnessed) to divide the debt in a specific manner
- Whether one spouse significantly increased the debt following divorce
Though the court ultimately determines how to split marital debt, its ruling doesn’t matter to a creditor. For them, the person whose signature appears on the loan agreement is the liable party. It’s this individual that they’ll contact to collect payment and initiate any legal action if necessary.
How divorce affects different types of debts
Credit cards
A divorce order may stipulate who’s responsible for paying a credit card, but the credit card company will deem the primary borrower liable for any unpaid balance.
If you have a credit card, you’re either the primary or supplementary borrower. The primary borrower is the one who originally applied for the card and signed the cardholder agreement. As such, they’re responsible for repaying all charges incurred on the card, including interest and fees.
A supplementary, or authorized user, has permission from the primary borrower to use the card for purchases. But they’re usually not obligated to make payments toward the outstanding balance.
We use the term “usually” because certain cardholder agreements contain clauses that impose payment responsibility on the supplementary user. In some cases:
- The primary and supplementary borrowers may be equally liable for charges incurred on all cards.
- The primary borrower is liable for charges on the main card, while the supplementary borrower is liable only for charges on the supplementary card.
Problems can arise if you’re unsure who obtained the card in the first place and under what circumstances. If the card appears on your credit report, it generally means that you agreed to be liable for the charges. The same concept applies if you see your name on the credit card statement. You may request your card issuer to provide proof that you applied for and accepted the card agreement.
Income Tax
With some exceptions involving asset transfers, you’re not normally responsible for tax debt your spouse owes to the CRA. This rule applies whether you’re married or going through a divorce.
However, if you own joint property with your spouse, not paying taxes may eventually result in the CRA registering a lien on the title to that property. The good news is that the lien will only apply to the tax debtor’s equity share in the property. In other words, a tax lien that pertains to one tax debtor doesn’t endanger the equity share of the other property owner.
What happens if you and your spouse were to sell the property after the CRA put a lien on it? In that case, the share of the equity belonging to the spouse with the tax debt would go to the CRA first to settle it.
Under section 160 of Canada’s Income Tax Act, the CRA can hold one spouse (the transferee) liable for the tax debt of the other spouse (the transferor) in the event of an asset transfer. Section 160 is triggered when one spouse transfers property to the other at less than fair market value to avoid paying taxes. This provision applies regardless of the transferee’s knowledge of the transferor’s tax liability. However, once the CRA issues the tax assessment, the transferee still has the opportunity to object.
Mortgage
Unlike a credit card or line of credit, mortgage debt is a secured loan, as your home functions as collateral. If you and your spouse acquire the mortgage together, the lender will hold both of you equally liable for the payments like other joint debts.
There are several ways to deal with a shared mortgage after divorce. The most straightforward and honest solution is to sell the home and split the residual money evenly. Other options include refinancing the mortgage only in one spouse’s name and buying out the other spouse’s share of the home equity.
You cannot include a mortgage and other secured debts in a bankruptcy or consumer proposal (unless you turn over the underlying assets to the creditor).
Car loan
Auto loan debt carries the same obligation as other secured debts: whoever is listed on the loan agreement as the original borrower is responsible for payments.
A joint auto loan can be problematic in a divorce, as only one person will use the vehicle. One strategy to consider is refinancing it under the person who will assume ownership. To do so, you’ll need permission from the lender. Alternatively, you can sell the vehicle and split the proceeds.
Debt and common law relationships
When a common-law relationship ends, the same rules apply to debt as in a dissolved marriage. You only share joint and co-signed debts with your partner. Your personal debts remain your legal responsibility, and your partner’s debts remain theirs.
Tips for protecting yourself from debt during a divorce
Going through a divorce or breakup can be stressful and emotionally devastating. But money problems can make the ordeal harder. If you’re in the middle of a relationship breakdown, do the following to make the process smoother:
- Remove your spouse as the supplementary credit card holder so they cannot add further charges to the account, if the bank will let you.
- Keep making timely payments on joint debts to preserve your credit score, regardless of whether your spouse contributes.
- Refinance any joint loans under your name if you plan to assume future debt payments.
- Freeze joint debt accounts so you and your spouse don’t incur additional debt.
- Close joint bank accounts (unless you still have ongoing mutual expenses)
- Check your credit report to ensure all the information is up to date, that it’s free of any errors, and that there are no debts in your name that you previously overlooked.
How to deal with debts you cannot afford to pay when going through a divorce
Following a divorce, it’s not uncommon for one or both spouses to experience severe debt problems, as the advantages of a dual-income household are now gone.
If your debt load turns out to be too much to manage, consult a Licensed Insolvency Trustee to learn what options you have to deal with it. One solution is to pursue insolvency, either bankruptcy or a consumer proposal. These two federal government debt relief programs will help you clear unsecured debts such as credit cards, payday loans, and past-due bills. They’ll also protect you against your creditors’ collection calls and legal action.
However, keep in mind that you won’t be able to discharge all your financial obligations; you’ll still be responsible for the following:
- Secured debts, such as a mortgage or auto loan
- Spousal support payments
- Child support payments
- Debts that arose through fraud or fraudulent misrepresentation
- Fines or penalties of the court
- Some student loans
Going through bankruptcy and divorce will be difficult, but the insolvency process is an opportunity to put debts behind you and start over financially. If your finances are in turmoil following a separation, book a free consultation with David Sklar & Associates to find out how to get a fresh start. We’ll learn about the specifics of your financial situation and work with you on the right solution to reign in your debts.
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