Every day, we hear about the high divorce rates, and how much money it costs to divorce. However, we rarely hear of how divorce can affect your credit score, and your ability to borrow as an individual (separate from your spouse).
Most couples are tied to each other through joint credit cards, mortgages and bank accounts. But with a separation or divorce, couples need to re-establish themselves as “financial individuals,” and the right time to do that is when they first separate. At that time, both parties most likely need to create a new financial identity in order to access some type of credit to start their new life.
Your Credit Report
First, let’s ask: what is a Credit Report? Most of us have never thought to request a copy of our Credit Report. This document gives you an overview of: your personal information; employment information; banking information; credit history; payment history; public record data; and collection data. It gives you a good picture of your financial liabilities, and how well you’re doing in living up to those obligations and paying your creditors on a regular basis. Assessing your Credit Report is especially important if you’re not the spouse who takes care of the household finances, or if you’re not the primary owner of the debt. You may be surprised by the credit cards and loans that are in your name.
You obtain your Credit Reports from credit bureaus. In Canada, there are two major credit bureaus: TransUnion (www.transunion.ca) and Equifax (www.equifax.ca).In the US, there are three: TransUnion (www.transunion.com), Equifax (www.equifax.com) and Experian (www.experian.com). Lenders use these reports to determine if an individual is a good risk, or in simpler terms, it tells them if individuals have the financial capacity to repay their debt. Real estate companies and prospective employers may also use the report to decide if an individual is a good risk for home ownership or employment.
Your Credit Report and Divorce
I’m sure some of your biggest fears revolve around the financial connection between you and your soon-to-be ex-spouse. As soon as you begin the separation process, consult with your legal advisor and financial advisor to determine the best way to handle your current financial situation, and to protect your rights as part of your divorce. Without the proper protection in place, your finances may be adversely affected for years. Here is some general advice:
- Pay off any joint debt, if possible. This is the most practical strategy to creating a good credit score.
- Make sure regular payments are made on all credit cards, lines of credit, the mortgage, etc.
- Close any joint bank accounts.
- Cancel any joint credit cards.
Don’t wait to do this until the divorce decree is finalized — it may be too late by then, and your delay may hinder your ability to acquire any credit of your own. For example, let’s say that pursuant to your divorce decree, your soon-to-be ex-is required to pay off two jointly-held credit cards. A few months later, he/she neglects to make the required payments, and the creditors contact you demanding payment. Although you have sent them a copy of your separation agreement or divorce decree stating that your ex is responsible for the debt, you may still be legally responsible for paying off the joint accounts if you have the cash to cover the debt. Plus, your creditors have the right to report any and all late payments to the credit bureaus — and if so, these negative marks would become part of your credit history. Your advisors will help you to sever these financial ties to your spouse early, so that you’ll be better protected and avoid a problem on your Credit Report. These are important first steps in establishing your own financial identity.
Your New Financial Story
Now, it’s time for you to become educated on financial independence! By creating a budget, you’ll discover if you’re a saver or a spender, or if you must alter any of your current spending habits.
In order to create a new financial story, first decide how you’re going to manage your finances going forward. Budgeting is a critical component in this process. It includes: determining monthly expenses (including any support payments you may have to pay), saving for your future, and your income, including any support payments you may receive. Here are the steps to follow:
- Start by recording your expenses each week for a month.
- Divide your expenses between Fixed (e.g. mortgage or rent, car payment), Flexible (e.g. utilities, groceries) and Fun (e.g. entertainment, lunches, coffee).
- Make sure you’re current on all of your payments.
- Add all of the items together and compare the total with your net income for the month to see what, if anything, is left over.
- If the amount is positive, add it to your savings; if it’s negative, then to look for ways to cut back on spending or generate more income
Let’s say you have a negative outcome to your budget after you complete the above exercise. You’ll need to ask yourself: “What am I able to cut back on, or cut out, in order to improve this situation?” Is your monthly car payment very high? If so, perhaps you can trade your foreign model SUV for a smaller domestic car. Or are you spending too much eating out? Perhaps you can make your lunch four out of five days a week. Sometimes, it’s the little things that add up and contribute to saving for your future. Prospective creditors are more willing to lend money when they see savings in the bank, and that all payments are current.
If you have a positive outcome to your budget, you can begin to plan how to invest your money.
Establishing Positive Credit
Another big step is organizing your finances. You’ve formally severed all ties to your spouse, and now it’s time to move forward. Here are some quick tips to help you establish positive credit:
- Establish a steady source of income.
- Pay all bills promptly.
- Open a checking account and don’t go into overdraft.
- Open a savings account and make regular deposits.
- Apply for a department store credit card — they are easier to obtain, and ensure that you make regular payments. (Note: you don’t have to charge a lot to this credit card, since interest rate is generally quite high, but the idea is to make regular payments on time, therefore establishing a good payment pattern.)
- Apply for a small line of credit and make regular payments.
Most importantly, stick to your budget! By staying faithful to it and spending only what you can afford, you’ll be able to live debt free and financially independent.
After your budget is in place and you have been sticking to it, check your Credit Report again after one year. It is also important to ensure that all of the information is correct, and that you’re no longer financially connected to your spouse. Check to make sure that all joint accounts and credit cards have been deleted. If you’ve moved, confirm that your new address is showing on the Credit Report. It’s important that all errors are resolved on a timely basis.
Jeffrey Schwartz is an executive board member of the Credit Association of Greater Toronto (www.cagt.ca) and the Executive Director of Consolidated Credit Counseling Services of Canada (www.consolidatedcredit.ca). CAGT is a non-profit association with a mission to provide a dynamic forum in which members can share information and expertise. Consolidated Credit is a national non-profit credit counseling organization that teaches consumers about personal finance through web-based budget and debt analysis tools, financial literacy community outreach programs and in-person or telephone counselling. .