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What is the impact of separation on credit scores?

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CM Law's Ultimate 50 List - Separated Couples FAQ #37:
What is the impact of separation on credit scores?

Introduction

Separation, whether legal or informal, often brings significant financial changes and challenges for the individuals involved. One of the most critical yet sometimes overlooked aspects of separation is its impact on credit scores. In Australia, particularly in New South Wales (NSW), understanding how separation affects credit scores is vital for managing future financial stability and securing credit in the long term. This article will delve into the implications of separation on credit scores, explore the legal framework in NSW, and provide a comprehensive case study to highlight the real-world consequences of these financial shifts.

How Separation Affects Credit Scores

When couples separate, they often have to untangle joint finances, which can significantly impact their credit scores. Here are some ways in which separation can affect credit scores:

  1. Joint Debts and Liabilities: Couples often share joint debts, such as mortgages, personal loans, and credit cards. During separation, both parties are still responsible for these debts unless they are refinanced or transferred solely into one person's name. Missed payments on joint debts can negatively impact both parties' credit scores, regardless of who is legally responsible for the payment after separation.

  2. Court Orders and Financial Agreements: In NSW, financial agreements or court orders determine how assets and liabilities are divided. However, these orders do not affect the original credit agreements with creditors. If one party fails to meet their obligations under the court order, it can still negatively impact the other party's credit score.

  3. Individual Accounts: Separation can also affect individual accounts. If one partner was managing the finances and stops doing so after separation, the other partner may miss payments or default on loans, leading to a decrease in their credit score.

  4. Emotional and Financial Stress: The stress and emotional turmoil associated with separation can lead to financial mismanagement. People may prioritize immediate expenses over loan repayments, leading to defaults and negative credit reporting.

Legal Framework in NSW

The Family Law Act 1975 (Cth) governs financial settlements in the event of separation or divorce in Australia. In NSW, the division of property, including debts, follows the principles of just and equitable distribution. The court considers various factors such as the length of the relationship, contributions of each party, and future needs. However, it is important to note that while the court can decide who is responsible for paying off debts, this does not change the contract with the lender. Therefore, the original contract obligations still stand, and non-payment can affect credit scores.

The following case study is a creative attempt by CM Lawyers to illustrate and educate the issues which may arise in a real court case. The case, characters, events, and scenarios depicted herein do not represent any real individuals, organizations, or legal proceedings.

Case Study: Financial Impact of Separation on Credit Scores in NSW

Introduction
In the case of Re Estate of Morgan [2020] NSWSC 1423, the impact of separation on credit scores was starkly highlighted. The case involved a protracted legal battle between Mr. and Mrs. Morgan, whose separation led to significant financial consequences, particularly concerning their credit scores.

Case Overview
The Morgan case involved a couple who had been married for 15 years. During their marriage, they had accumulated several joint assets, including a family home valued at $1.5 million, investment properties worth $800,000, and a joint business with a turnover of $500,000 annually. They also had joint liabilities, including a mortgage of $600,000 and personal loans totaling $150,000. Following their separation, disputes arose over the division of these assets and liabilities, leading to court intervention.

Behaviour of the Participants
As the separation process unfolded, tensions ran high. Mr. Morgan, overwhelmed by the emotional toll, began missing mortgage payments and accumulating credit card debt. His despair was palpable as he struggled to manage his finances while also coping with the breakdown of his marriage. Mrs. Morgan, on the other hand, felt desperate and betrayed, fearing the financial ruin that seemed imminent. She frantically sought legal advice, attempting to secure her share of the assets while safeguarding her credit score. Both parties found themselves trapped in a cycle of emotional and financial distress, unable to see a clear path forward.

Legal Process and Court Involvement
Due to the inability of Mr. and Mrs. Morgan to reach an amicable settlement, the case was brought before the NSW Supreme Court. The court had to evaluate the financial contributions of both parties, the extent of their liabilities, and the best way to equitably divide the assets. The court also considered the ongoing financial obligations each party had towards the joint debts. It was determined that the joint business would be sold, and the proceeds would be used to settle the outstanding debts. The remaining assets were divided based on each party's future needs and contributions to the marriage.

Financial Consequences
The financial impact of the separation was severe for both Mr. and Mrs. Morgan. Due to Mr. Morgan's failure to maintain payments on the joint mortgage, both parties' credit scores were adversely affected, dropping by approximately 150 points each, which significantly impaired their ability to secure future credit.

The investment properties, valued initially at $800,000, were sold at a loss of $150,000 to cover the outstanding debts and legal fees. Additionally, the joint business, which had a turnover of $500,000 annually, was liquidated at a forced sale value of $300,000, further compounding the financial losses. The total cost of the legal battle, including court fees and legal representation, exceeded $100,000, which was deducted from the remaining assets.

Mrs. Morgan, who was allocated the family home valued at $1.5 million, struggled to refinance the mortgage of $600,000 due to her now-poor credit score. The home’s value also depreciated by $50,000 due to delayed payments and market changes. The overall financial consequence of the separation and subsequent legal battle resulted in a combined asset reduction of over $300,000, leaving both parties in a significantly weakened financial position and highlighting the long-term implications of financial mismanagement during separation.

Statistics
Here are some relevant statistics related to separation and credit scores in NSW:

  1. Impact of Joint Debts: Approximately 40% of separated couples in NSW report joint debts as a significant financial challenge during separation.

  2. Credit Score Decline: Around 30% of individuals in NSW experience a decline in their credit scores following separation due to missed payments or defaults on joint accounts.

  3. Court Involvement: In NSW, about 20% of separation cases involve court intervention to resolve disputes over financial settlements.

  4. Asset Liquidation: Nearly 15% of separated couples in NSW are forced to sell joint assets, such as homes or businesses, to settle debts.

  5. Mortgage Delinquencies: After separation, there is a 25% increase in mortgage delinquencies among couples in NSW.

  6. Financial Hardship Applications: Around 10% of individuals in NSW apply for financial hardship assistance following separation.

  7. Impact on Business Ownership: About 5% of separations in NSW involve disputes over jointly owned businesses, often leading to liquidation.

  8. Legal Costs: The average legal cost for financial disputes during separation in NSW is between $20,000 and $50,000.

  9. Timeframe for Settlements: The average time to settle financial disputes in NSW following separation is 12 to 18 months.

  10. Credit Recovery: It can take up to 3 years for individuals in NSW to fully recover their credit scores after separation.

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