Where Credit’s Due: Protecting Your Credit Score During Divorce
A guide to the inner workings of credit scores – and how to protect your credit score during divorce.
Rachel is the sort of person who plays by the rules. A stay-at-home mother of three, she has always lived within the family budget and paid bills on time. When she and her husband, Jack, split up, she followed her obligations under their divorce decree to the letter. She was therefore shocked to find out that her mortgage application after divorce had been turned down because her husband had destroyed her credit rating.
He’d always paid our mortgage on time during our marriage,” Rachel says. “So when the court ordered him to keep up the payments until we sold our marital home, I didn’t think anything of it. Besides,” she adds, “I couldn’t have made those payments myself during our divorce proceedings. He was the one earning the salary. Where was I supposed to get the money from?”
It is important for divorcing couples to understand early on that if they have joint debt, their credit ratings are inextricably linked until they separate their obligations. Therefore it is in their mutual self-interest to make payments on time. A bad credit score makes it difficult for both parties to move on. The time to act is before there has been a missed payment. Divorce is stressful and can sometimes lead to erratic financial behavior on the part of a spouse. It is therefore advisable for divorcing persons to take control of payments that affect their credit rating as soon as possible.
Remember, court orders aren’t magic
Most divorcing couples believe that a divorce decree can relieve a spouse of a joint financial obligation. Not true! Court orders and divorce decrees can’t save divorcing couples from financial peril if one or both spouses act irresponsibly. “People have a naive expectation toward court orders, like they’re magic,” says Barbara Stark, divorce lawyer and principal of Divorce Resolutions Resources. “But court orders are not magic. People have to learn to take responsibility for their own finances and their own lives. The sooner they learn this, the more quickly they’ll be able to limit the damage [to their credit rating].”
David Cross, mortgage broker at Landmark Financial LLC agrees with Stark’s assessment that court orders can’t do much to protect a divorcing couple’s credit rating. This is because when a married couple signs a joint loan application, both spouses make a legal agreement with the creditor to pay back the debt. A court cannot overturn this contract (unless it is unlawful for some other reason). An amendment to any contract requires the agreement of all parties, including the creditor. In Rachel’s case, her ex-spouse stopped making mortgage payments and Rachel’s credit score plummeted. “The only way to get her name off the mortgage note was to pay it off or refinance,” Cross explains.
In certain circumstances a divorce decree can help a mortgage broker “explain” a borrower’s, like Rachel’s erratic payment history to a mortgage lender. But Cross warns that this process, which requires the borrower to submit a letter of explanation and the lender to customize its underwriting, doesn’t always work. “It’s possible to get an exception but difficult,” he says.
Why credit bureaus will disregard your divorce decree
Credit scores matter because they measure for businesses what sort of a credit risk you are. According to Cross, they are “the driving force” in determining how much you will pay for a loan. The higher your risk (i.e., the lower your score), the more money you will pay to borrow – whether for a mortgage, auto loan, or credit card.
The most widely recognized credit score is FICO, computed by Fair Isaac & Co. In the U.S., your FICO score is based on financial information tracked by three major credit bureaus: Equifax, Experion, and Trans Union. (For a free credit report from these agencies, go to www.annualcreditreport.com). In Canada, the three major credit bureaus are Equifax Canada, NCB Inc. and TransUnion Canada. (Visit www.creditkarma.ca/ for a free credit report.)
FICO takes into account a lot of different credit information in determining your score; more than half of the calculation comes from your payment history and the amounts you owe. So if your mortgage payment or other loan is past due because your spouse has failed to make a court-ordered payment, this will still have a direct impact on your FICO score.
How to protect your all-important credit score during divorce
Regardless of what your divorce decree says or what’s fair, if you have a joint debt, you’re responsible for it. So it’s important to take the following steps to protect your score:
- Identify all joint accounts. A good way to do this is to get your credit report from each major credit bureau: Experian Trans Union, and Equifax. These reports will show open department store credit cards that you might not have used in years. If you’re not sure whether your spouse is authorized to use a particular card, check with the creditor directly.
- If possible, close all joint accounts immediately. This is easy to do if there is no outstanding debt. If, however, you owe something on the account and can’t close it, freeze it so that no one can continue to use it. Then transfer the joint debt from joint name to sole name. This has to be done equitably.
- Make sure to make at least the minimum payments on joint credit card bills while you are in the process of closing/freezing joint accounts. Even one late payment can affect your FICO score.
- If you don’t have a credit card in your own name, now is the time to get one. Building your own credit history takes time, so it’s best to get started.
- In the case of a joint mortgage (secured debt), your best options are either to sell the marital home and pay off the mortgage (cleanest choice), or to refinance the mortgage in the sole name of the person responsible for paying it. If you decide to refinance, make sure to do so before the divorce is final. Sometimes one spouse won’t qualify for refinancing on his/her own; it’s best to know this upfront.
- While you’re waiting either to sell your home or refinance it, make sure your mortgage payments are current — even if it is your spouse’s responsibility and you have to borrow from friends/family to do so. Remember that missed payments affect your credit rating, too. According to Stark, a client in Rachel’s situation would have been better off making the mortgage payments herself and then having Jack reimburse her under court order if necessary. “The only way to protect your credit rating is to make payments yourself,” Stark says.
- Make sure not to take your name off the title if your name is still on the loan. This will only remove your name from ownership — not from your obligation to pay off the debt.
If only I’d known….
It’s been two years since Rachel’s divorce and she is still repairing her credit score. Jack’s failure to pay the mortgage will stay on her credit report for up to seven years. Fortunately, her prompt payment of bills in her own name since her divorce has caused her FICO score to improve enough that she can now get a mortgage — albeit at a higher rate. “If only I’d known how credit scores worked before my divorce was final, I would have done things differently,” Rachel said. “I would have saved a lot of money.”
Elizabeth Cox, is a Certified Divorce Financial Analyst® (CDFA®) and an independent financial advisor with Raymond James Financial Services in Wilton, CT. The focus of her practice is to help clients achieve financial security and independence throughout the divorce process and other life transitions.