“What’s yours is mine and what’s mine is yours” is a typical mantra of married couples. But when it comes to debt, that saying can be scary. Fortunately, the general rule is that spouses are not responsible for each other’s debts (in the legal sense, of course). Therefore, when agreeing to assume a liability, the borrower’s spouse can usually rest assured he or she will not be held responsible if the borrower is unable to meet his or her obligations.
There are caveats to this general rule, however. As a financial advisor, it’s important to maintain an understanding of the legal intricacies and potential pitfalls associated with spousal debt, so you can help paint a clearer picture for your clients. Below, I’ll provide a closer look into situations where your clients may need to be prepared to take on liability.
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Community Property States
If a married couple resides in a community property state, debts are likely to be considered owed by both spouses, regardless of who signed for the loan. As of 2019, there are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. A few important rules apply in these states for student loans in particular:
- Federal student loans: If a federal student loan was taken out after the couple became married, the debt would likely remain the responsibility of the borrower, regardless of the state the couple lives in.
- Private student loans: Married borrowers should be far more careful when taking out private student loans, as they are more likely to be subject to community property legal standards.
- Loans incurred prior to marriage: If the spouses incurred their student debt prior to entering the marriage, joint liability would likely not attach to the loans, regardless of whether they’re federal or private.
Cosigners and Joint Debt
You may run into situations where a client has unwittingly assumed liability for the debt of his or her spouse. If a spouse cosigned the loan, then the spouse may have assumed liability for the debt if the borrower is unable to pay. In that case, if the primary borrower completely discharges the debt in bankruptcy, the creditor could pursue legal action against the spouse to recover the debt. This is the primary reason clients should avoid cosigning for their spouse’s debt whenever possible.
In addition, if a married couple decides to enter into a joint debt, then, typically, the spouses are “joint and severally liable” for the spousal debt—meaning the creditor can come after one or both of the spouses for the full amount owed.
If enabling joint use of a credit card is the goal, clients should consider appointing one spouse as the primary cardholder and the other as an authorized user of the account. An authorized user has no liability for the debt associated with the account but has the authority to make purchases and have his or her own card. While both spouses typically do not need to sign to be liable on a debt (other than for a home mortgage), it is sometimes necessary in order to increase a credit limit or in cases where one spouse is unable to obtain the credit on his or her own. In such cases, it is important that the cosigner considers whether it is necessary to obtain the credit and fully understands the implications of his or her signature.
Income-Based Repayment for Student Loans
If you have clients who are looking into federal income-based student loan repayment options, they should be aware that their spouse’s signature is usually required. The spouse should be sure to carefully read anything he or she signs related to a loan, but, typically, the lender requires the spouse’s signature for verification of income purposes only, not to impose liability upon the spouse for the debt.
When finalizing a divorce, a judge can order the split of not only the marital assets, but also of the debts of the parties. Generally, if a spouse has incurred a debt individually, that debt will remain with the person who incurred it; however, the judge may award assets disproportionately to the individual with the higher indebtedness if the judge determines fairness demands it or that the debt was incurred to benefit the marital household. In the case of joint debt, a judge can order that only one spouse is responsible for the debt, notwithstanding that both spouses are legally liable to the creditor.
If you have clients going through a divorce, be sure they know that, typically, creditors are not bound by the terms of a divorce decree and are free to pursue an individual for a debt that a judge has ordered the individual’s former spouse to pay. If a spouse was ordered by a judge to pay a joint debt, however, and then files for bankruptcy, the bankrupt spouse is typically unable to discharge his or her obligation to the former spouse to satisfy the debt.
An Opportunity to Build Trust
The combination of marriage and debt can be a touchy subject. And as a financial advisor, I’m sure you’ve had clients seek your guidance on topics such as this, above and beyond their investment portfolios. By helping your clients understand the rules regarding their spousal debt and any potential liability they may face, you’ll create a golden opportunity to ease their concerns while continuing to build their trust in you.
Have you helped your clients sort through tricky marriage and debt situations? Share your stories and ideas with us below!
Commonwealth Financial Network® does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.