Divorce Articles Section
Divorce Bank Account Blues - What Happens to Your
Marital Debt During a Divorce
Debt, Credit, and Bankruptcy
We have referred to property as either marital or separate. The
same classifications apply to debt. In general, both you and your
spouse are responsible for any debts incurred during the marriage
it does not matter who really spent the money. When the property
is divided up during the divorce, the person who gets the asset
usually also gets the responsibility for any loans against it.
Its in both of your best interests to pay off as many debts
as possible before or at the time of the final decree. To do so,
use whatever liquid assets you have bank accounts, money
market funds, stocks, bonds, or cash values from life insurance.
It may make sense to sell assets to accumulate some extra cash.
The most easily sold assets include extra cars, vacation homes,
and excess furniture. (Dont expect to get much for used furniture
unless it has value as an antique or collectors piece.)
If you cant pay off the debts, then the decree must state
who will pay which debt and within what period of time. There are
generally four types of debt to consider: secured debt, unsecured
debt, tax debt, and divorce expense debt.
Secured debt includes the mortgage on the house or other real estate,
and loans on cars, trucks, and other vehicles. It should be made
very clear in the separation agreement who will pay which debt.
If one spouse fails to make a payment on a debt that is secured
by an asset, the creditor can pursue the other spouse.
Unsecured debt includes credit cards, personal bank loans, lines
of credit, and loans from parents and friends. These debts may be
divided equitably. The court also considers who is better able to
pay the debt.
For unsecured debt, any separation agreement needs to include a
hold-harmless clause. This will indemnify the nonpaying spouse,
which means that the paying spouse gives nonpaying spouse the right
to collect not only all missed payments, but also damages, interest,
and attorneys fees if payments are not made. Without a hold-harmless
clause, the nonpaying spouse has the right to collect only the missed
Often, the legal decision and the financial outcome are very different
things. This is a lesson Paul learned the hard way. Tracy and Paul
were married eight years, during which time Tracy ran her credit
cards to the limit with her compulsive spending. The court held
Tracy solely responsible for paying the $12,000 in credit card debt.
After the divorce, however, Tracy didnt change her ways and
was unable to pay off her debt. The credit card companies came after
Paul, who ended up paying them off.
In a case like this, one solution would have been to pay off the
credit cards with assets at the time of divorce or for Paul to have
received more property to offset this possibility.
Just because the divorce settlement is final doesnt mean
you are exempt from possible future tax debt. For three years after
the divorce, the IRS can perform a random audit of your last joint
tax return. In addition, the IRS can question a joint return
if it has good cause to do so for seven years. It can also
audit a return whenever it believes fraud is involved.
To avoid surprises, the divorce agreement should spell out what
happens if any additional interest, penalties, or taxes are found,
as well as where the money comes from to pay for defending an audit.
We know of countless horror stories where the unsuspecting spouse
(usually the ex-wife) is all of a sudden obligated for a huge tax
bill and doesnt have a clue how it happened.
Divorce Expense Debt
Although it isnt always clear who is liable for debts incurred
during the separation, typically these debts are the responsibility
of the person who incurred them. An exception would be if one spouse
runs up debts he or she is unable to pay to buy food, clothing,
shelter, or medical care for the kids. The other spouse is probably
obliged to pay those expenses.
You will accrue other costs during the divorce process, including
court filing fees, appraisals, mediation, and attorneys. Other less
obvious expenses are accounting, financial planning, and counseling.
The separation agreement needs language that states who is responsible
for these expenses.
Divorce expenses may accrue after the decree, such as attorney
fees for doing QDROs, title transfers, and tax preparation for the
final joint tax return, mediation fees, and long-term divorce counseling
for the parents or the kids. Who pays? You do, unless it is spelled
out clearly so there are no disputes at a later date.
Dividing Marital Property and Debts
Many people try to divide each asset as they discuss it
your half of the house is $4,000, my half of the house is $4,000.
Since you will rarely divide the house like this, this may not be
the most useful way to go about it. It may be more practical to
list each asset as a whole item under the name of the person who
will keep it.
For example, in the wifes column, list the marital equity
in the house if she is thinking of continuing to live there. List
the entire value of the husbands retirement in his column,
if that is your initial inclination. An advantage to this method
is that it allows you to see the balance, or lack of it, of your
initial plan as you develop it. If you want to know dollar values,
you may need a third party, such as an appraiser, to help you determine
This is the time to have a real heart-to-heart discussion with
your about-to-be-ex about the range of his or her sense of fairness.
- Is the only possibility for a 50-50 division of things by value?
- Are you more interested in cash than in things?
- Will you take less than 50 percent if your share is all cash?
- Are you more interested in future security than in present assets?
- Are you willing to wait for a buyout of your share, such as
house selling or retirement, and are you looking for more than
50 percent to compensate you for waiting?
- Are you interested in a lopsided agreement (more
to one of us than the other) to compensate for the larger earnings
made by you or your spouse?
- Do you want to be made whole meaning ending
up where you were at the beginning of the relationship?
- Do you need to be compensated off the top for some
contribution you made to the acquisition of property?
- Is there a possibility that any assets or investments are hidden?
If you both can agree on a generic plan that meets each of your
ideas of fairness, you will find you have an agreement that practically
writes itself. The bonus is that you save on lawyers fees.
As you allocate the debts, decide first whether they are marital,
separate, or a mix. Then agree who will pay off the balance of each.
Remember that the problem of unsecured debts may be handled more
easily as if it were a monthly credit card payment than a division
of your property.
Think about the long-term effect of the division of assets and
debts you are considering. For example, suppose you get all assets
that appreciate slowly or depreciate, and which take money to maintain
(home, car, furniture). Then suppose your spouse takes all assets
that increase in value or produce income (stock, retirement accounts,
rental home). Guaranteed, in a few years after the divorce, what
in the short term appeared to be fair or equal
will look quite different. Your spouses net worth will far
exceed yours and the gap will just continue to widen.
The word bankruptcy strikes fear in the hearts of many people
especially those going through divorce. You may be trying
to decide whether it is better to ask for alimony or a property
settlement note and are caught in indecision. Perhaps your spouse
has threatened either to leave the country if alimony is required
or to file bankruptcy if money is owed or a property settlement
note is due. Lets look at some of the rules of bankruptcy
as they apply in divorce situations.
Two types of bankruptcy are available: Type One allows you to develop
a payoff plan over a three-year period and Type Two allows you to
liquidate all of your assets and use the proceeds to pay off debts,
erasing debts that cannot be paid in full.
Type One bankruptcy may preserve the assets and allow the debtor
to pay off all the secured debt, as well as a portion of the unsecured
debt, and discharge the rest of the unsecured debt. The debtor needs
to make payments under a plan that is approved by the bankruptcy
Type Two bankruptcy forgives all unsecured debts and requires the
forfeiture of all assets over a certain minimum protected amounts.
Creditors have the right to repossess their fair share of the assets.
The net proceeds from the sale of assets are divided pro rata among
Here are some things to remember:
- If a spouse files bankruptcy before, during, or after divorce,
the creditors will seek out the other spouse for payment
no matter what was agreed to in the separation agreement.
- While you are still married, you can file for bankruptcy jointly.
This will eliminate all separate debts of the husband, separate
debts of the wife, and all jointly incurred marital debts.
Caution promissory notes or property settlement notes, especially
unsecured notes, are almost always wiped out in bankruptcy. Some
secured notes, depending on the property that secures them, can
also be discharged. Heres what happened to Cheryl: Sam and
Cheryl divided all their assets. To achieve a 50-50 division, Sam
still owed Cheryl $82,000. He signed a property settlement note
to pay Cheryl the $82,000 over a ten-year period at 7 percent interest.
After the divorce, Sam filed for bankruptcy and listed the property
settlement note as one of his debts. Cheryl never received a penny
of the money that was due her.
Note: Certain debts cannot be discharged in bankruptcy. These include
child support, maintenance, some student loans, and recent taxes.