While managing your credit score, to maximize it, your scores should be part of any personal financial plan, it is a critical task for divorcing couples who must successfully complete and implement their agreements as required by the courts. Credit is tricky in the best of situations and divorce adds layers of complexity and costs. Therefore, understanding basic credit score management, the specific credit risks related to divorce, and ways to protect your credit through your divorce is urgently important.
Three factors make managing your credit very difficult at any time:
- Credit can be very counterintuitive where actions that should help your credit, can have the opposite effect.
- There are many events that will help your credit in the long-run, but will hurt your credit for first several months.
- Your credit depends on your exact circumstances. Thus, something that will help your credit can actually hurt someone else’s credit.
Three additional factors make managing your credit during a divorce even more difficult:
- Credit scores often go down through a typical divorce process due to rising credit card balances, multiple credit inquiries, and new accounts.
- Most couples, and even their professionals, make at least a few mistakes with credit during their divorce lowering their scores even further.
- Completing the divorce process usually requires a series of transactions for each spouse. Not only can many of these lower credit scores even more, but lower scores can make each one progressively more costly.
To overcome these factors and protect your credit during divorce, you must also understand the specific credit risks related to divorce and ways you can protect your credit by minimizing or even eliminating their impact. Let’s start with a list of routine risks to your credit you should expect to face in divorce:
DIVORCE CREDIT SCORE RISKS
- CREDIT INQUIRIES – Divorce requires numerous credit inquiries. From prequalifying for a mortgage to keep the marital residence or buying a new home to exploring credit card options, your credit scores will drift lower with each inquiry.
- OPENING ACCOUNTS – Frequently, divorce also requires opening several new accounts including mortgages, credit cards, car loans, and even bank accounts with overdraft protection. Each new account can significantly lower your credit score for several months.
- CLOSING ACCOUNTS – Because maintaining joint debt after divorce is a huge risk and problem, most divorce decrees require all joint debt accounts be closed through payoff or refinance. Closing accounts is a real wild card since it can cause one person’s scores to jump and another person’s scores to dive. It can even have the opposite impact for each spouse on a joint account.
- INCREASING BALANCES – Divorce is costly. Couples traditionally put divorce related fees on credit cards causing balances to rise increasing the credit utilization rate on each card and across all revolving debt which can cause credit scores to drop up to 100 points in some cases.
- LATE PAYMENTS – With all the stress and disruption of a divorce, missed payment are not unusual. The problem is that even a single late payment can easily lower your credit score 50 to 100 points.
- COLLECTIONS – Missed payments for a medical co-pay or utility do not show up as a late payment on your credit report. Instead, they appear as a collection from a debt collector. A single collection for under $100 will usually lower your credit score over 100 points. Worse, in one of the most unusual credit situations, paying off a collection almost always lowers your credit for a year or more.
- JUDGEMENTS – Judgements are like collections, although paying them does not make your credit worse in most cases. In divorce, most judgements are from not paying income or property taxes.
- DISPUTING CREDIT – Disputing credit during a divorce can really make a mess of things including scores and your ability to qualify for financing. If you find errors on your credit report, you need to determine the potential impact and balance that with the time, cost, and probability of success with correcting any error. Furthermore, you can proactively correct errors on your own instead of filing a dispute and waiting for the creditor to respond.
Now that we identified the main risks, let’s look at ways you can help your credit through the divorce process:
WAYS TO PROTECT YOUR CREDIT DURING DIVORCE
- DON’T DO ANYTHING… YET –The single most costly and most common mistake I see people make during divorce is to immediately open and close credit accounts. Anxiety and fear cause people to feel they need to do something. In their search for advice, they find a tip online or from a friend who has been divorced five times who tells them this is a good idea.
- GET PROFESSIONAL ADVICE – You must speak to competent experienced divorce professionals with specific knowledge about how to protect credit through divorce to determine your exact situation, risks, and needs.
- MAKE A PLAN – Once you understand your situation, risks and needs, you can work with your professionals to identify any unintended consequences of each option and create a detailed Divorce Credit Plan to minimize any adverse impacts to your credit during divorce.
- TIMING EVENTS – Spreading out any credit events like inquiries, opening new accounts, closing accounts etc. will avoid significant dips by allowing your credit to recover from one event to the next keeping it above critical levels.
- SEQUENCING EVENTS – You should also look to order the events in your divorce plan to accomplish the most important and costly task first. You must account for any tasks that are a prerequisites for other tasks in addition to any that would preclude you from completing anything else in your plan.
- MINIMIZE EVENTS – Review the plan to eliminate and consolidate any events that are not required to reach the desired outcome. Anything else can be done after your divorce is final and fully implemented.
- PAY DOWN REVOLVING DEBT – The best way to support your credit scores during divorce is to pay down revolving debt. This can include paying balances down, paying them off completely, or just paying enough each month to prevent the balances from rising.
- MAKE PAYMENTS ON TIME – During divorce, you and your spouse must work together to ensure you do not miss a single payment. Even a single late payment can damage your credit to the point that it can completely alter your plans.
- CREDIT MONITORING – Credit monitoring during and after your divorce will not prevent your credit score from going down by itself. However, it is a useful tool to help you protect your credit score. You can use it to confirm any planned corrections, inquiries, new accounts, and closed accounts. You can also identify any unexpected or fraudulent activity in real-time instead of much later.
- CREDIT FREEZES/LOCKS – During divorce, you and your spouse are at heightened risk of identity theft. From banking to credit and real estate with various companies in between, your personal financial information must be shared far more than normal which increases the chances that could be compromised along the way. Use these tools to prevent any unauthorized access.
- NO CREDIT REPAIR! – I have yet to meet someone who felt they got the results they were promised and received good value for the money they spent working with a credit repair company. With a little information, you can usually get better results faster on your own which is very important during divorce.
- NO CREDIT CONSOLIDATION! – Most people don’t realize that credit consolidation can damage their credit as much as foreclosure and bankruptcy. This is truly a very big decision for which you must get input from legal and tax experts before moving forward, especially before or during a divorce.
- IMPLEMENTATION PLAN – The final, and single most important way you can protect your credit through the divorce process, is with a Divorce Decree Implementation Plan. This can be a standalone document or integrated into the Separation Agreement. It includes every required task that is part of the decree with every detail of when and how it will be implemented and by whom. It is the only way to ensure everything in the decree can be implemented on time as planned without any unnecessary damage to the couple’s credit and resulting unnecessary costs.
To successfully complete their divorce with the best outcome possible, couples must protect their credit. To do so, they must first learn basic credit score management, recognize the specific credit risks related to divorce, and know how to protect their credit. Then, they must create a plan for the divorce process as well as a separate Implementation Plan to execute every required task in their decree without needless costs. Even with knowledge and some experience managing credit, mistakes are common and costly.
Considering most couples, and even many professionals, lack specific divorce and credit related knowledge and experience, to devise effective plans, working with subject matter experts is highly recommended. Finding the right professionals with extensive experience structuring divorce agreements and implementation plans saves a lot of time and money. In fact, the savings from even the simplest mistakes typically far exceeds the cost of getting professional help.