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Divorcing couples who have joint debts often face costly financial surprises after their divorce. Here's why:
How to avoid liability for joint debts during your divorce
Ontario law says that since both spouses signed for the debt, both are legally responsible for the full amount owed, even after the divorce. This means the bank (or other creditor) can sue either spouse for the debt, even if one spouse agreed to pay the entire amount in the divorce agreement. As a result, one spouse's late or missed payments can ruin the other spouse's credit rating, making it hard or even impossible for the innocent spouse to borrow money, lease a car or rent a home.
Here are three ways divorcing couples can avoid liability for joint obligations:
1. Pay off all joint debts before your divorce. Both spouses should sell family assets so they can pay off joint debts, such as the mortgage. Even if the spouses are on good terms and trust each other completely, they should still pay off joint debts. This is because neither spouse can know what financial problems the other might face in the future. So, to play it safe, divorcing couples should pay off all joint debts.
2. Refinance joint debts before your divorce. If the spouses cannot pay off all joint debts, then they should at least refinance them. In a recent case, my client moved out of the matrimonial home. His wife wanted to stay in the home with their children, to minimise the negative impact of the divorce on their children. The house and the mortgage were in both my client’s and his wife’s name. The only way they could have paid off the mortgage would have been to sell the home, which they didn't want to do. At the same time, I insisted that my client not be responsible for the mortgage. We worked out an agreement in which my client's wife obtained a new mortgage in her name, and used the funds to pay off the joint mortgage.
3. Enter into a well-drafted separation agreement. In some cases, couples simply cannot pay off all joint debts or refinance them. This is often true for young couples, who may have more debts than assets. In this case, it is important to have your divorce lawyer draft a separation agreement that will protect each party as much as the law allows.
In a recent case, I drafted a separation agreement for a client. A few months later, my client's wife defaulted on paying her share of the joint loan. Eventually, my client recovered his money because of the carefully worded terms in the separation agreement.
Even so, the best separation agreement won't always protect the spouses. That's why paying off or refinancing joint debts are a divorcing couple's best options.