Lesson 9 Debts
Get control over your family debts
Lesson 9: Debts
Welcome to Lesson 9. In this lesson we teach you what to do about your debts after you separate. Your choices of debts are as important as your choices of assets. The goal of this lesson is to teach you the most important factors to consider when choosing the debts you are willing to keep.
The general rules for this section are to eliminate all high interest debts and all joint debts as soon as possible. The remainder of your debt will depend on what assets you wish to keep. Before we get into high interest and joint debts we are going to go over the general idea of debt.
What is Debt?
Debt is any amount of money that you owe to someone. Debt can be a mortgage, a loan, finance payments for a vehicle or any amount of money you have borrowed and need to pay back. Debt includes money loaned to you by family members.
Most of us are never taught the right way to use debt. Debt is not bad if used in the right way. By this we mean debt is not bad if used to make you money. If you use debt to buy a rental property, then it can be good debt. If debt is used to buy a more expensive vehicle, or to buy a new boat, then it is bad debt. If debt is used to keep assets that you can’t afford after separation, then it is most likely bad debt too.
In other words, you are best off to keep the debts that help you keep the good assets. However, you must also make sure that your debt does not cost you more than your income asset makes you.
General Idea with Debt:
Our concept of “good debt” versus “bad debt” is a common personal finance and business view of debt. Debt is only good when it is used to buy an income asset. These include rental properties, investments, businesses etc. Debt is therefore bad when it is not used to buy an income asset. This means any asset that is not cash or an income asset is not worth getting into debt for.
Even if you want debt there are two important factors to consider. Firstly, you can’t get debt that costs more than the income asset makes you. For example, don’t get a mortgage at 12% if your rental property only generates you 10% of income. Or in other words, don’t buy a rental property that loses you money every month.
Another example is taking loans to buy stocks. If you take a loan at 3% interest per year and invest in a stock that makes you 7% interest a year then you can make a lot of money. However, if you take an 8% loan to make 7% interest, you will not make any money. So always pay attention to the interest rate and the monthly payments. If they cost you more than your asset makes you, you may want to sell your asset and pay off the debt.
Secondly, even if you pick the best interest rate, you must not get into too much debt. In the business world, we call this “overleveraging” yourself. If you get into more debt than you can afford, it doesn’t matter if the debt is used for income assets. You will risk going bankrupt. I got into this problem a few years back. I received advice to take out a loan and invest that loan in the stock market. I followed their advice and for a couple of years I really struggled to pay my monthly debt payments. Luckily, I was able to lower them over a couple of years, but I was living quite poorly in order to afford them. The stock market ended up doing well and I made a good amount of money, but I almost went bankrupt before I was able to make that money. If I took a greater loan amount I may not have been able to recover.
How is Debt Used in Family Law:
In family law, debt is used to calculate your equalization payment. Debt is part of the “dividing your stuff in half” part of equalization. Remember in lesson 7, you do not simply give half of your debt to your ex-spouse. You add your debt together and subtract them from your assets to determine your “Net Family Wealth”. Debt is similar to assets in that you and your ex-spouse can choose which debts you will keep.
You have the freedom to take all of the debt or take none of it as long as you both agree. I have seen some clients offer to take all of the family debt in order to avoid paying a large equalization payment. I have also seen clients willing to give up a portion of their wealth if their spouse agrees to take all of the family debt.
Debt can be used as a tool to keep the best assets. For example, if taking a huge loan allows you to keep a huge investment account then you may want to make that deal. However, debt can also add to a bad financial situation. For example, if you owe a lot of spousal support, child support and you own a lot of expensive costing and debted assets, debt can be that further step that brings you into bankruptcy.
Most of my clients struggle with their debt. Their struggle is mostly connected to wanting to keep as many assets as possible. They want the house, the vehicle, the boat, the ATV and the cottage. In order to get those assets, they agree to take over the majority of the family debt. It is so common that I would say this is one of the biggest reasons for clients struggling after separation. Taking debt in order to keep your bad assets is one of the worst things to do.
The rule of thumb is you should only take debt that helps you get cash and income assets. Other than that you should consider selling your asset and paying off the debt.
Debt After Separation:
One of the biggest problems my clients struggle with is getting into debt after separation. This is a very serious issue. If you have to use debt to pay your expenses then your expenses are too high or you are keeping too many costing assets. You must fix these issues. Taking debt to pay your expenses will never improve. You will go more and more into debt. The only way out of this situation is bankruptcy.
Another strategy my clients use is to take a loan to replenish all of the assets they lost at separation. This can be new vehicles, new household furniture or new houses. Often my clients expect to get a huge payment in the end so they believe it won’t hurt them to get into debt now. This strategy is one of the worst strategies you can make. Never get into debt now with the expectation that you will get more money later. I have several examples of clients who took this approach only to end up with nothing. I had one client who got into $60,000.00 of extra debt trying to keep her home. In the end, she had to sell the home and she was only entitled to $60,000.00 for her share. Guess where that $60,000.00 went. It went to pay off her debt. She ended her separation with nothing and her ex-husband got $60,000.00.
So we know that we shouldn’t get into more debt after separation. If we feel that we need to use debt to pay our expenses we either need to sell some assets or lower our expenses. What do we do with the debt we already have after separation?
Now that we have covered debt we need to create a plan for what debt we will keep and what debt we will eliminate. As stated earlier, you do not need to eliminate all debt if it is connected to an income asset. Since you can keep some debt you will need a set of rules and guidelines to help you decide what debt to keep. These guidelines are as follows:
- Eliminate all high interest debt
- Eliminate all Joint Debt
- Keep the Debt that helps you keep the Income Assets
These really are the only things you need to worry about with your family debt. You definitely want to make sure that you have lower interest debt. You want to eliminate all of the debt you own jointly with your ex-spouse and you want to keep the debt that will help you keep the best income assets.
High Interest Debt
Your first, most important step is to eliminate ALL high interest debt. High interest debt is anything that is over 7%. The reason why we say anything over 7% is high interest is because that is higher than what you are likely to average as an investor. Typically, you will only average 7-9% from your investments long term. This means that any debt that costs your more than 7% will likely force you to lose money.
If you have debt that is 8% or higher you must make eliminating that debt a top priority. This means that you need to eliminate your credit card debt as soon as possible. If you have payday loans or Money Mart type loans, then you need to eliminate them IMMEDIATELY. These debts guarantee you will never get economic freedom. You cannot wait a couple of years for those debts to be eliminated. They must be eliminated immediately.
Any debt that is less than 7% is not as devastating to you. You can have the freedom to take some time. There are two reasons why you might want to keep high interest debt. Both of these reasons are not good enough excuses.
The first reason might be that the debt is a joint debt and your ex-spouse refuses to make any payments. You may feel angry that your ex-spouse is not paying this debt but you cannot afford to wait for things to become “fair”. I have seen too many clients refuse to pay off credit cards or payday loans because their ex-spouses refuse to make any payments. In the end, their debt becomes so high that they both lose tens of thousands of dollars. In this case talk to your lawyer about getting an order to sell an asset to pay it off. Or get your lawyer to reach an agreement that you will pay the debt off and get a credit for the payment.
The second reason you may try to keep high interest debt is because you do not want to lose an asset. As stated earlier, unless your asset is making you more money than your high interest debt is costing you, then you should immediately try to sell the asset (after talking to your lawyer of course). My clients often try to keep their high interest debt so they can keep their houses, vehicles, recreational vehicles. I have even seen clients take ten thousand dollar trips on a payday loan, while still fighting with me about selling their assets to pay the debt.
You are better off selling an asset to pay off the debt and buying that asset later.
Joint debts are a very dangerous part of family law debt. The major reason why they are dangerous is your ex-spouse can keep taking debt out in your name even if you separated. The worst I had seen was a husband who maxed the family’s joint line of credit one day after separation. This was around $70,000.00 taken overnight. I have also seen multiple wives go on ten thousand dollar trips on a joint line of credit. Joint debts are equally dangerous to both spouses.
You should immediately freeze any joint debt you have. You would do this by calling your creditor and advising them to freeze your debt. Put this in writing as well so that you have a record of it. You want to eliminate your ex-spouse from being able to pledge anymore debt in your name.
If you want to know why you should do this right away consider my other client. After separation the family agreed to sell a bunch of their assets in order to pay off their credit card. It was paid to zero. A few months later, the credit card went back up to $5,000.00. A few months after that their second credit card increased. They had already sold their assets and so they had nothing they could use to pay them off. At family law, my client’s ex-spouse was required to pay the credit card, but in reality, he still had to make the monthly payments for months or risk having his credit hit. In this case he ended up having to pay the debt. This situation can be quite common and even when your ex-spouse pays the extra joint debt off you will likely have to make monthly payments for months before you get this resolved.
After you freeze your joint accounts, your next step should be trying to close them. Even if your ex-spouse cannot spend anymore money on that account, you are both liable for that account. For example, let’s say you settle on your ex-spouse paying off the rest of the joint debt. Let’s say a year after they never pay it. Despite family law saying they should have paid it, you are still liable to the creditor. Your name is still on that debt.
For this reason, you need to make a plan to have that debt paid off in full or for your name to be removed. It is rare that a bank will agree to remove your liability from a debt, but I have seen it happen.
Never Let Your Ex Keep A Joint Debt Alive
One common issue my clients have is they have such high levels of debts that they can’t remove a spouse’s liability. An example of this is the matrimonial home. Some spouses want to keep the home and can afford to make the payments, but their credit is not high enough to get a new mortgage. In this case, they often ask you to keep your joint mortgage and let them pay it off every month. This is a terrible idea.
Firstly, if their income is not high enough to take your name off the mortgage now, then how will you know they will be able to when the mortgage renewal is due. Also, what if they lose their job in the meantime and stop making the mortgage payments. Do you now have to make those payments on top of your payments? How do you recoup those mortgage payments if your ex-spouse is broke? These are messes you do not want to be in.
I have even seen keeping a joint debt fail for the person staying in the matrimonial home. My client owned the matrimonial home as joint owners with a joint mortgage. Since he couldn’t take her name off the mortgage, he couldn’t take her name off the title. When he went to renew his mortgage five years later, he discovered that she failed to pay a different bank loan and the bank placed a lien on his property. He lost about $60,000.00 in equity because he couldn’t take her name off the title.
If your spouse cannot take your name off your mortgage, then you should have the home sold. This goes for any asset. If your name cannot be removed from the debt, then you should either keep the asset or sell it.
Vehicles are another common example. One spouse often has better credit and so they will place their name on a vehicle debt. When they separate, their ex-spouse asks them to keep their name on the debt. This often ends with disaster as well. If your name is on a vehicle debt, then you must either keep possession of the vehicle or sell it. Do not let your ex-spouse keep the vehicle if you are on the debt.
How to Eliminate Joint Debts:
What do you do when you have a joint debt you want sold? You should always meet with your lawyer before you make a decision, however, below are some options you can consider:
- If the joint debt is attached to an asset: you should make reasonable efforts to keep the asset. Try to prevent your ex-spouse from taking the asset.
- If you have the asset you can either work with your lawyer to have the asset sold or you can arrange for your ex-spouse to take your name off of the debt.
- If your ex-spouse has the asset, then you can apply to the court to have the asset sold immediately and debt paid by the sale proceeds.
- If the debt is unsecured (not attached to an asset): then you should seek an agreement to sell some assets to pay off the debt.
- You can also agree to have your ex-spouse transfer the debt into their sole name. I recommend giving them only thirty days to get this done. If they claim that they can’t do it within thirty days then they are unlikely to ever get it transferred.
- If your ex-spouse refuses to sell any assets to pay off the debt, then work with your lawyer to create a plan to sell some of your own assets to pay off the debt.
- Make sure you close the debt account once it is paid off.
Dealing With Other Types of Debt
Your only other plan is to keep the debts that help you get the best income assets. Your best way of doing this is by listing the debts from best to worst. This can either be from highest interest rate to lowest or by highest monthly payment to lowest. I would recommend listing by interest rate, but you are at liberty to do whatever is most important to you.
Once you list the debts out, start thinking of which debts you can keep and which ones you would like to eliminate.
Debt Connected to Bad Assets
There are some debts that are attached to bad assets. The most common are vehicle loans. The loans are attached to the vehicle. My typical advice for these types of debts is to sell the asset and pay off the debt. You can also transfer the asset to your ex-spouse as long as they get a loan that pays off your loan.
This same concept goes for any recreational vehicles, debts attached to furniture, or any asset that does not generate you an income.
Here are some scenarios to help you plan.
Scenario 1: You have a house with a joint mortgage, a vehicle with a debt attached to it. Some household furniture, a credit card loan and an unsecured loan. You have an investment account and a pension. What do you do?
You want to immediately pay off the credit card debt. You also want to have the home sold and the joint mortgage paid off. You want to keep the investments and the household furniture. There may be sale proceeds from the sale of the home as well. You may be willing to take the unsecured loan if it lets you keep the investment account, some household furniture and some net sale proceeds of the house. You may decide to divide your pension in half or keep it in full and give your ex-spouse the sale proceeds of the home. You should try to sell your vehicle and buy one for cheaper. Pay off your vehicle loan and get a smaller loan.
Scenario 2: You have all of the good assets and your ex-spouse has some minor high interest debt. This is a pretty common situation, one spouse is often the higher income earner and the better saver. In this scenario you will likely be the one with the most assets and the most debt. You may have a home in your own name with a mortgage, an investment account, a pension, two vehicles both in your name and both with high vehicle loans. Your ex-spouse has possession of one of the vehicles. You have a joint credit card with a $15,000.00 max and your ex-spouse has their own credit card.
In this scenario, your best assets are the investment account and pension. You want to freeze and eliminate the joint credit card immediately. You do not need to care about your ex-spouse’s credit card because your name is not attached to it. You would ideally like to sell both vehicles for cheaper ones, however, you must sell your ex-spouse’s vehicle. When you have to pay your ex-spouse support, you will not be able to afford their insurance and vehicle loan payments too. You should sell your home and split the sale proceeds. You could also transfer the home into your ex-spouse’s name if they are able to take over the mortgage. You can give them the equity in the home in exchange for you keeping the investment account and the pension.
In this scenario, the vehicles and the house were the worst assets. The joint credit card and the vehicle loans were the worst debts. Overall their financial situation was quite good.
Scenario 3: You have all bad assets except your ex-spouse has a good pension. This is a very common situation for many clients. For example, you have a home, two expensive vehicles as joint owners, an ATV, a boat, a riding lawn mower, expensive paintings, household furniture and a utility trailer. The only good asset is a pension. The debt you have is a mortgage, a credit card in your own name, a joint line of credit over $50,000.00. And every recreational vehicle has some form of debt attached to them.
Your best asset is the Pension. The second best asset is the household furniture. The paintings are neutral as they don’t cost you anything to maintain. THe utility trailer and the riding lawn mower do not cost you money to maintain either. The ATV and Boat, each have a debt attached to them and are the worst assets.
You should first pay off your credit card. Consider selling the riding lawn mower and the trailer to pay off that credit card debt. You should then sell the boat and ATV. You should pay off the debts attached to them. You should keep the household contents. Get the Paintings appraised and offer them to your ex-spouse or have them sold. Take the proceeds from the sale to pay off the joint line of credit.
Since there are no good assets (other than the pension) you should sell the home to pay off the joint line of credit. You can also transfer your interest in the home as long as your name is removed from the mortgage and the line of credit. You should insist on getting half of your ex-spouse’s pension. This is the best asset. In the end you will have all (or almost all) of your debt paid off you will have half of a pension and your monthly expenses will be greatly reduced.
For the vehicles you should try to get each other’s names removed from the vehicle loans. If you cannot then they should both be sold.
I hope these three scenarios gave you some insight on how you can use plan to use debt to help you keep the best assets.
List your debt out from lowest interest rate to highest interest rate. Place any assets that are attached to the debt. This does not mean the debt used to buy an asset. This means the asset that is secured against the debt. In other words, if the bank can take an asset if you fail to pay your debt, then it is secured. The best examples are mortgages are attached to your house, your vehicle is attached to your vehicle payments and your credit cards aren’t secured against anything.
Once you have listed out all of your debts and have placed the attached assets beside them you want to do the third step. Plan to eliminate all of the high interest debt. This is done with your lawyer’s help. Ask your lawyer what to do. Plan out what debts you are able and are willing to take over in order to keep the best assets.
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