Protecting and Improving Your Credit Before, During and After Divorce

Your financial future depends on good credit scores and clean credit reports with no derogatory items.

In this article, I review the steps and offer some tips for handling your credit reports, joint credit cards, and other debts, so your credit will be protected before, during, and after divorce.

As you move forward into your financial future, it is critical to protect your credit and credit scores and improve them whenever possible.  A bad credit report caused by derogatory items such as late or missed payments, collection accounts, bankruptcy, foreclosure, high credit utilization, too many inquiries, etc., will result in a low credit score.

This can have a detrimental impact on your ability to refinance, obtain a new mortgage, or even just rent an apartment. You will find yourself financially stuck if your credit scores are too low, and any plans you may have had to refinance or buy a property will be delayed until you can fix those items, or they naturally fall off your credit reports (Most derogatory items fall off after 7 years, but it’s 10 years for bankruptcy).

In and of itself, just the act of divorce cannot ruin your credit unless you have a vindictive spouse who purposely runs up bills on joint credit cards and then doesn’t pay on time or doesn’t pay at all.  Hopefully, that’s not your situation, but divorce can still have a significant impact on your finances, including household income, bill paying plans, and debt repayment plans.

In many cases, attorney fees and other divorce-related expenses are paid with a credit card, and this will increase your utilization rate, which will ultimately decrease your credit score unless your outstanding balances (utilization) are paid off or substantially reduced in a timely manner.

Your utilization rate is a percentage that is calculated by dividing the amount of credit you have already used by your total credit line. For example, if you have used $8000 out of a credit line of $10,000, your utilization rate is 80%. Most credit experts suggest you keep your utilization rate under 30%, but lower is even better.

Your Credit Score

Good credit scores and clean credit reports are two of the most important components for a successful outcome in obtaining a refinancing or a new mortgage.  Here are the steps I recommend you follow to ensure your credit scores are protected and your credit reports remain as clean as possible.

Obtain a copy of your current credit reports and scores.

Your current credit reports will give you a lot of valuable information, including your credit score and your credit history (including all open and closed accounts, current balances and any derogatory information, number of inquiries, etc.).

There are three main credit reporting agencies:  Transunion, Equifax, and Experian.   It is important to pull your credit report from all three agencies and examine each report in detail for accuracy. Most free services such as Credit Karma will also give you a credit score, but those scores are typically a Vantage score, not a FICO score.  To the best of my knowledge, no bank, mortgage lender, credit card company, etc., will use a Vantage score. In most, if not all, cases, they will use a FICO score.

Therefore, to get the true FICO scores that most lenders use, I strongly recommend that you use myFICO.com. It is a subscription service that will give you all your updated FICO scores and credit reports from all three agencies. These are provided on a monthly basis, and myFICO.com will inform you by email and/or text anytime there are any changes to your credit report/score 24/7. As of this writing, you can subscribe to myFICO.com to get reports and scores from all three agencies for under $40 per month – which, in my opinion, will be money well spent (I, personally, have been subscribing for years).

Also, understand there are many different FICO scores – some are used by lenders for auto loans, some for credit cards, and others for mortgages. There are even variations of FICO scores within each category. Each lender makes their own decision about which FICO scores they will use for which type of loan, and this is totally their decision. For mortgages, the lender will pull your FICO credit score from all three agencies and use the middle score (Equifax uses a FICO score 5, TransUnion uses a FICO score 4, and Experian uses a FICO score 2). If you have a co-borrower(s), they will use the lowest middle score of all borrowers.

Once you receive all three credit reports, carefully examine each one for all debts that belong to you alone, as well as those you hold jointly with your spouse, and make a list of all debts, and their minimum monthly payments, to discuss with your divorce attorney (You will need to include this debt information on your Financial Affidavit at the beginning of the divorce process). Please keep in mind that lenders do not necessarily report to all three agencies – you may have a credit card, auto loan, and other debt that only reports to one or two agencies. Therefore, each credit report may be slightly different and have different credit scores.

Report any inaccuracies

Each credit reporting agency has a procedure for reporting inaccuracies and/or disputing various items. For instance, you may have to provide proof showing you paid certain bills on time, or you may need to work with the financial institution that put the derogatory information on your credit report.  Either way, this process could take time, especially if there is a dispute, so start the process as soon as possible.

Discuss with your divorce attorney how debt will be divided in your divorce

Where you live will be a factor in how debt will be handled in your divorce because Equitable Distribution States and Community Property States view debt differently.

In Equitable Distribution States, debt in just your name is typically considered your individual debt unless some or all of it was incurred for the benefit of the family, such as buying groceries.

In Community Property States, all debt incurred during the marriage (usually up to the Date of Separation) is considered Community debt, meaning the debt belongs to both spouses. This is true even if the debt is in only one spouse’s name and even if the other spouse had no knowledge of it.

Therefore, the division of debt and who will be responsible for the payment of that debt is critically important and could impact your ability to refinance or obtain a new mortgage.

The more debt you are obligated to pay, the higher your DTI (Debt to Income Ratio) will be, and that will be a very important factor in determining if you will be approved for a refinancing or new mortgage and, if so, at what interest rate.

For secured loans, such as an auto loan, the loan typically travels with the asset. So, for example, whoever gets the car, also gets the auto loan.

Despite the above, if you are negotiating a settlement agreement with your spouse and not going to court and having a judge decide, then you can pretty much agree to handle debt, or any other aspect of your divorce, any way you want to, as long as it’s lawful, mutually agreed to with your spouse and the final Agreement is not totally lopsided in favor of one spouse over the other.

Freeze all Joint Accounts with Creditors

Any joint credit accounts with outstanding balances will remain the responsibility of both parties in the eyes of the creditor, regardless of what your Divorce Settlement Agreement states.  Therefore, they should be frozen immediately (so no new debt can be incurred by either spouse), and the balances paid off as soon as possible.

The common wisdom is that once the balances on joint accounts are paid off, those joint accounts should be immediately closed. However, most people, including divorce attorneys, don’t realize that one of the factors that credit agencies use to determine your credit score is the average age of all your credit accounts. If you were to close a joint account that you had for many years, that will reduce the average age of all your accounts, and that could reduce your credit scores.

So, you might be walking a fine line here. Whether you should wait to close joint accounts until after you refinance or obtain a new mortgage or if you should close it immediately will depend on numerous factors and the specifics of your divorce.

That’s another reason to add a divorce mortgage broker to your team as early as possible. They will be able to determine if closing accounts might have a negative impact on your credit scores.

Of course, this must be coordinated with your divorce attorney since there will need to be language in the Divorce Settlement Agreement that states when those joint accounts will be closed and that neither party will incur any new charges on those accounts.

Remember, if there are any accounts with balances that must be paid off, you will not be allowed to close those accounts.  How to deal with those unpaid joint accounts and who will be obligated to pay them will be part of your divorce negotiations. It is critical that the appropriate language will be added to your Divorce Settlement Agreement so that any joint debt your spouse will be obligated to pay will not be included in your DTI.

When one spouse will be responsible for the full payment of a debt, that debt is considered to be a “Contingent Liability” and typically should not be included in the DTI of the spouse who is not responsible for the payment of that debt.

Open New Accounts in your Name

Most couples have joint checking and savings accounts. You need to close these as soon as possible, but first, discuss this with your divorce attorney. Each state has its own specific laws governing how funds can be withdrawn from joint accounts when couples divorce.  Make sure to stop all automatic payroll deposits into these joint accounts as well and have them re-routed to the new accounts you open in your name only.

If you haven’t done so already, you’ll need your own bank accounts and credit cards solely in your name, but opening these accounts is best accomplished while you are still married. Go to a bank where you don’t have joint accounts with your spouse, and open both a savings and a checking account. You’ll need your own credit cards, as well, and starting that process now while you are still married is extremely important. It can be difficult for people with little or no income to establish credit on their own, so prepare yourself for the possibility that securing credit could be somewhat time-consuming and is likely to require more than simply filling out an application or making a single phone call

Talk to a divorce mortgage broker as soon as possible.

If you plan to keep your home, buy out your spouse’s share of the home’s equity and refinance the mortgage into just your name, or you plan to buy a new property, talk to a divorce mortgage broker as early as possible in the divorce process is critical.  Why? Because we can take a look at your current credit situation (scores and reports) and make suggestions on how to increase your scores and clean up your reports, all with an eye to help you get the best possible mortgage terms given your then situation.

Here are several other reasons to bring a divorce mortgage broker on to your divorce team as soon as possible:

Reason 1:  We can help brainstorm ways to repair your credit and increase your credit scores.

This is where a divorce mortgage broker can really help you when consulted early in the process.   The process of raising your credit scores and cleaning up your credit reports is a long-term play.  If you are looking to refinance or get a new mortgage and your credit reports are less than desirable, you actually may have some time to clean it up.  After all, your divorce is likely to take several months, if not a year or two.

Action Items

1. Pay your bills on time.
2. Pay down your debts.
3. Fix or dispute any errors
4. Call and negotiate lower interest rates
5. Don’t incur any new debt on joint credit cards, and don’t incur any new debt in your own name that you do not intend to pay off immediately.

After  a few months of diligent work, your credit scores should start to increase.

Reason 2:  Suggest ways to establish your own credit

If all of your credit were in your spouse’s name (and you were just an authorized user on his/her credit card), you might realize that you don’t really have a credit history – this is very problematic.

As soon as you can, open a credit card in your name only, pay off the balance each month or, if you can’t qualify for a regular credit card, get a prepaid or secured credit card.  A secured credit card is a card where you deposit a certain amount of money with the lending institution, usually a minimum of a few hundred dollars, and that amount becomes your credit line. These “secured” credit cards are the first step in showing you can manage your credit, and if you make timely payments and don’t exceed your credit line, not only can you improve your credit, but some of these institutions might “graduate” you to a real credit card after several months and refund the money you deposited for that initial secured card.

Reason 3:  Divorce Mortgage Brokers only get paid a commission on the total amount of the refinanced or new mortgage if and when it closes.

 So, in essence, you are getting free advice!

To-Dos:

1. Obtain a copy of all three of your credit reports and your credit scores.
2. Review all three reports carefully and dispute any inaccuracies.
3. Review this information with your divorce attorney and divorce mortgage broker and strategize on how to improve your credit and how the debt should be handled.

FYI:

 Most FICO credit scores range from 300 to 850, with the median score around 720. A score of 800 – 850 = Exceptional credit; 740 to 799 = Very Good; 670 to 739 = Good; 580 to 669 = Fair; and 300 to 579 = Poor.

For information about my forthcoming book, Divorce House Sense: Can You Keep Your Marital Home or Will You Have To Sell? please visit: nextactproperties.com/books