Applying jointly for a loan can improve your chances of being approved, but should a married couple use their combined credit to consolidate debt, especially if one partner has a bad credit score? The correct answer depends on what debt you are consolidating and why.
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Advantages and disadvantages of a joint application
When you apply for a joint debt or loan as a couple, you are saying to the lender: we would like to use our combined credit capacity, and our combined income, to support our loan application.
There are advantages to applying together for a debt consolidation loan.
- If one spouse’s debt-to-income ratio is too high, you can use the income of the second spouse to improve this lending factor.
- Similarly, if one partner has a bad credit score, the application may be approved on the merits of the second co-applicant or cosigning spouse.
- By improving the quality of your application and overall creditworthiness, you may qualify for a lower interest rate loan than the high debt spouse can acquire.
While you can borrow more money with a shared application, the downside is that as co-borrowers, you both will be legally obligated to repay the loan.
A joint debt creates what is known as a ‘joint and several’ liability. Both parties are 100% liable to repay all the debt. This can create significant financial risk for the spouse that is now assuming responsibility for debts created by the other spouse.
Credit score issues
Lenders are in the risk management business. To qualify for a low rate consolidation loan, at least one applicant will need a good credit score. You are relying on the positive credit history of one spouse to override the negative history of the other. However, making a joint application means that the debts that were affecting your spouse’s credit score will now impact yours.
- Your credit score may fall because you have taken on new credit.
- Multiple applications create hard hits on your credit report that can also hurt your credit score.
- A new loan can also increase your credit utilization ratio until you begin to pay down the consolidation loan.
Joint debt means you are responsible and liable under the terms of a signed loan agreement. It doesn’t matter who says they will pay the loan. If you divorce or separate from your spouse, and they stop making payments, the lender will look to you to repay the debt.
Debt cannot be allocated in a divorce or separation agreement. While your separation agreement might call for a 50-50 split of debts, or your spouse might agree he will make the monthly payment because the debt was his originally, the agreement between the two of you has no legal impact on your lender.
Further, it is not possible to have a name taken off a joint loan without the lender’s permission, and because the lender approved the loan based on a joint application, they may not be willing to do so. In the event of a marital breakdown, you could be left with payments you can’t afford.
Marital assets and property
Another factor to consider is whether you want to risk any family assets to consolidate unsecured debt like credit card debt.
Converting unsecured debt into a secured consolidation loan is one of the riskiest consolidation strategies we see.
If you are fortunate enough to own a home, a home equity loan, or home equity line of credit can seem like an attractive loan consolidation approach to deal with one spouse’s problem debt. However, merging family debt into your mortgage creates two financial risks; you are now liable for larger mortgage payments and, if you and your spouse default, you risk losing your home.
One of the most common reasons people find themselves unexpectedly filing a bankruptcy or consumer proposal is a job loss or income reduction. Consolidating debts with your spouse means you are both equally responsible. If one spouse loses their job, you may no longer have the income capacity to keep up with your consolidation loan payments. The option for one spouse to file bankruptcy to deal with their separate debt, leaving the other financially stable, is off the table once you agree to consolidate your debt legally.
With student loan debt is a growing issue among millennials, many are entering their marriage years already in debt. Today 1 in 5 of our clients carry student loan debt, and this rate is growing rapidly. If one spouse has been unable to earn enough to repay their student loans, it may make more sense for them to consider student loan relief options rather than burdening the two of you with ongoing loan repayment.
Student loan consolidation is also not always a good idea as you can lose the tax benefits of the deductibility of interest on Canada student loans.
Is a joint loan the best option?
Problem debt is problem debt. It may not make sense to shift bad debt to your partner. This may not help either of you get out of debt.
The reason most couples consider a joint consolidation loan is to use the good credit history of one spouse to help the other deal with overwhelming debt. However, if one spouse is experiencing financial hardship because of their loan payments, burdening the second spouse with the same joint legal obligation may not be the best course of action.
Before consolidating one spouse’s bad debts into a family debt, it may make more sense for the spouse with debt issues to talk with a Licensed Insolvency Trustee about loan forgiveness. The spouse with high consumer debt may want to consider filing a bankruptcy or consumer proposal as a form of debt relief rather than transfer the debt obligation to the other.
There is a secondary benefit in keeping personal responsibility for personal debts. This can preserve the credit rating and credit capacity of the spouse with good credit for future needs. That spouse can still qualify for a mortgage while both spouses save money for a down-payment after completing a consumer proposal, for example.
Filing insolvency does not affect your spouse’s credit. This is one of the common misconceptions of how a bankruptcy filing impacts a spouse. The spouse filing insolvency can work to improve their credit without harming the credit of their partner.
In the end, you must decide as a couple about consolidating your debt through a joint loan. Talk together about how and who will make the monthly payments, what happens if your finances or relationship changes, and how refinancing with a joint consolidation loan will affect your future financial goals.