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How to Handle Debt in a Divorce

Survey after survey shows that disagreements over money is one of the two main reasons married couples fight (the other is sex). If the couple had differing philosophies about saving and spending during the marriage, odds are they fight over dividing their debts during a divorce. Divorce will be complicated and the couple would benefit greatly from the help of a financial advisor to shepherd them through it.

Financial advisors can provide financial planning before, during and after the divorce. Plus, they can make splitting spouses aware of their options, the value of their assets, and how their financial decisions will impact their future.

As an attorney specializing in family law, many of my clients are professionals, entrepreneurs, executives or the spouses of high earners, all of whom ask for help in solving challenging legal and financial puzzles. I’ve also worked with divorcing couples to address the allocation of marital wealth that arises, including the division of assets.

State laws deal with debt at the time of divorce in different ways. Most states differentiate between debt acquired before, during and after the marriage dissolves. Some states, such as California, treat debt accrued during marriage as marital or community property that must be divided in the divorce. This typically results in an equal division of debt.

Nine states including Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin are community-property states, which means that each spouse holds an equal, undivided one-half interest in all the property acquired during the marriage, unless an exception applies, and that each spouse will receive one half of the community property in the divorce. If one spouse owned property before getting married, and it still exists as of the date of separation, it is deemed separate property. The court may not divide that property. The couple may have acquired an interest in a separate property, however, and this interest must be divided in the divorce. If a spouse owned the property prior to getting married but it sold during marriage, they may be able to assert a separate property interest in various community-property items. For instance, if one spouse sold a house they owned before marriage and used the proceeds to place a deposit on a house purchased after marriage, they might be entitled to a credit for that separate-property contribution. The division of property is often difficult because it can be emotionally charged. But like all aspects of divorce, this should be taken one step at a time. By starting with the items most easily divided, the separating couple can avoid paying lawyers to litigate the value of what may be invaluable items.

One common question that financial advisors may encounter is over the responsibility for paying credit card bills and making house payments during the proceedings. Until the divorce concludes and all the debts have been reassigned, the marriage remains responsible for the payment of community obligations. Depending on the circumstances, the court may require the parties to equally divide these obligations during the divorce process, or it may order one spouse to pay some of the debt with the understanding that this spouse will receive credit in the final accounting. In regards to credit card debt, it will be divided as part of the overall division of the community property and debts. When allocating debts, the court considers what is fair.

Unfortunately, sometimes bankruptcy and divorce go hand-in-hand. When couples find themselves getting divorced with one or both spouses also facing bankruptcy, they may feel like everything is falling apart at once. As a general rule, there are more reasons to declare bankruptcy prior to divorce, rather than during or after:

  • Discharging unsecured debts (e.g., credit cards, medical bills) improves the cash flow for both parties after the divorce.
  • Eliminating or reorganizing debts streamlines the divorce process, leaving the parties with one less issue to negotiate or litigate.
  • Discharging debts before divorce ensures that you will not be responsible for that debt if your partner later defaults or files for individual bankruptcy.

A spouse who is thinking of filing for bankruptcy while the divorce is pending should seek professional assistance from an advisor who can answer questions, such as which form of bankruptcy is best for their situation and how it will affect their future. If a spouse filed for bankruptcy during the divorce, it’s important for them to contact their attorney, as well as a financial advisor right away.

Filing for bankruptcy in the midst of a divorce can have a significant impact on the legal process, and can, in fact, freeze the proceedings. As an expert, you will want to advise a spouse on the following: whether certain debts will likely be discharged in the bankruptcy, how substantially a bankruptcy may delay the divorce, and whether bankruptcy is an appropriate option for them.

If they fail to act, they may be held responsible for debts the ex-spouse was ordered to pay. Certain debts, such as child and spousal-support obligations cannot be discharged in bankruptcy. When the couple files for bankruptcy together before a divorce, they avoid many conflicts, and the divorce process may be more tolerable. However, there may be valid reasons to delay a bankruptcy until after the divorce or to avoid bankruptcy altogether. Couples should carefully consider the pros and cons of pursuing this option, and the reasons for wishing to do so as it will harm their credit, with a lasting effect of many years.

Determining who is responsible for certain debts is an important but frustrating part of the divorce process. As an expert, you can help ensure the best possible outcome when it comes to dividing marital debt and dealing with the critical financial decisions the process brings. This includes gathering accurate and complete debt information and asking clients to write future protections into the divorce decree, in the event that a spouse refuses to pay their share. Regardless of how debts from the marriage are divided, divorcing couples should feel hopeful that they will gradually build financial resources after the process is final and emerge with a brighter financial future.

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