Many times one of the divorcing spouses is NOT obligated or liable for the loan and therefore their credit may not be impacted. I'm referencing obligation to the lender, not obligation under the divorce agreement. Sometimes one of the spouses did not have had good enough credit while the other spouse had strong enough income and credit to qualify for the loan by himself or herself. Other cases could include a house and mortgage that was already in a spouse's name prior to the marriage. This is vital to know in a short sale situation.
How does a foreclosure or short sale affect the non-obligated spouse?
Important disclosure: The credit bureaus do not publish their secret formulas, so I cannot give a definitive answer to the question. I am not a lawyer, a mortgage underwriter, or a credit repair specialist. The above professionals should be consulted to get an authoritative answer. Laws and practices may also differ from state to state.
Okay, we have to get a little bit technical for a minute, to clarify often confusing concepts:
A loan has two primary parts
- A personal commitment to pay the loan back: This is evidenced by what is called the promissory note. Whoever is on the note gets the benefits of building up their credit when payments are made on time but they also get the disadvantage of damaging their credit if the payments are not made.
- An additional document that is called a mortgage. The mortgage pledges the house as security for the loan. The mortgage document permits the lender to go through legal process of seizing the house in a foreclosure if the loan payments are not paid. At the end of foreclosure process the lender sells the house to a new buyer to recover their investment.
You can be on the mortgage but not on the note. You may have pledged your house as security but not made a personal promise to pay.
If you are not on the note, then falling behind on payments, doing a short sale, or even losing the house to foreclosure may not hurt your credit at all.
How do you know if you signed the note?
- Check your monthly mortgage statement. Is it addressed to you or only to the other co-owner.
- Call your lender. Ask them if they report payment history on your credit report. If they won’t even talk to you, you’re probably not on the loan!
- Run your credit separately from the co-owner. Does your mortgage even show up?
- Check your closing documents. Is your name on the note?
- Call the closing attorney who closed your loan. Ask them to interpret your closing documents.
- Ask a mortgage broker to review and interpret your loan documents.
- Ask a credit repair professional to review and interpret your loan documents.
Caution: Even if your credit report may not reflect foreclosure activity, you may still have to report on future loan applications that a house you owned had foreclosure activity.
I get these questions often in divorce and separation situations. In a divorce situation it is vital that your divorce attorney be made aware of who is obligated on the note. The divorce lawyer should be fluent in real estate issues, especially if the house cannot sell for enough to pay off the loan. A Realtor who specializes in short sales should also be consulted. Many divorce lawyers in the Louisville KY area call me to assist with a short sale, to rid the mortgage issue from the already stressful divorce negotiations.
The internet is full of conflicting information about the impact of foreclosure and short sale activity on your credit. Each case is specific and my intent here was to point you in the right direction to determine your situation.