Understanding Individual and Joint Debts

How Jointly-Owned Property and Debts Are Affected

If a married couple files a three- to five-year Chapter 13 plan of reorganization and decides during the course of the Chapter 13 to get divorced, there are several ways the combination of bankruptcy and divorce affects the Chapter 13 case, including how jointly-owned property and joint debts are treated in the Chapter 13 bankruptcy case.

Understanding Individual and Joint Debts.

One of the obligations a debtor has in any chapter of bankruptcy is to list all its debts. The Bankruptcy Code provides that one of the duties of a debtor is to “file…a list of creditors.” 11 U.S.C. § 521(a)(1)(A). The allocation of debts in bankruptcy is an important consideration when contemplating bankruptcy and divorce.

Individual debts are from one spouse, while joint debts are from both spouses. For example, if a married couple has a credit card that both spouses applied for, both spouses are responsible to pay back that debt. If, on the other hand, only one spouse applied for a credit card, only that spouse is responsible for that debt.

Often, when a married couple purchases a house together, both spouses are responsible to pay the mortgage, and this debt would, therefore, be considered joint debt. Typically, the obligations of joint debtors are both joint and several, which means that the creditor can collect the full amount for either spouse. If both spouses filed taxes jointly, both spouses also would be jointly and severally liable for any tax liabilities.

In bankruptcy, debts are listed as joint or individual. Certain kinds of debts can become liens on various forms of property, which can be reorganized in a Chapter 13 case. For example, if a couple has a joint credit card that has resulted in a judgment, that judgment may become a lien on the couple’s home, which, under certain circumstances, can be avoided in a Chapter 13 bankruptcy.

Another common example are homeowner’s or condominium association dues. Typically, both spouses are responsible for these dues, and these associations can easily place statutory liens on the marital home. The difference between joint and individual debt is an important step in understanding bankruptcy and divorce.

Understanding How Joint Secured Debts Can Be Modified in a Chapter 13

In a Chapter 13 bankruptcy case, secured debts such as car loans or property liens can be reorganized to benefit the debtor. The Bankruptcy Code gives the debtor the ability to modify secured debts under 11 U.S.C. §§ 506 and 522. Under these provisions, secured loans can be termed out over the course of the debtor’s Chapter 13 repayment plan, interest rates can be lowered, and the principal balance on a loan can be reduced to the value of the loan’s collateral.

Some common examples of how this works in real life come into play with a car loan and home-equity line of credit on a home. These benefits are an important consideration that married couples should consider when contemplating bankruptcy and divorce.

In the car loan scenario, if the married couple purchased a car together, they typically both own the car and are both responsible for the debt. The debt is a secured debt because the auto finance company retains the authority to repossess the car if payments are not made. If the car loan has a high interest rate – say 14.99 percent, it can be lowered to Prime plus 1 percent, which is significantly lower.

Under certain circumstances, the value of the car loan can be lowered to the value of the car, so instead of paying a high interest rate on a large principal balance, a Chapter 13 debtor can pay a much lower interest rate on a lower principal balance, and this can be termed out over the course of the debtor’s Chapter 13 three-to five-year Chapter 13 repayment plan. When thinking about bankruptcy and divorce, if a married couple has filed for divorce while in bankruptcy, they may lose the ability to reorganize this secured debt.

Another important benefit of a Chapter 13 bankruptcy is the ability to strip liens. This comes into play with any kind of lien – whether the lien is a voluntary lien, such as a home equity line of credit, or an involuntary lien such as a homeowner’s association lien, tax lien, or judgment lien. Under certain circumstances, these liens can be stripped, which means that after the Chapter 13 plan is complete, the debtor no longer has any obligation on these debts because they have been stripped to be unsecured debts which are paid last in a Chapter 13 bankruptcy. This cost-saving benefit may be lost if a couple goes through a bankruptcy and divorce.

Bankruptcy and divorce can be done simultaneously, but it requires a careful look at all of the debts that the couple has to determine the true impact of bankruptcy and divorce. If you have questions about bankruptcy and divorce, please sign up for our newsletter Fresh Chapter or call (410) 670-7060 to learn more.