Thursday, February 23, 2012

Community Property States and Defaulted Spousal Debt

No matter what you may have heard, in most cases debt collectors cannot legally pursue you for debts that are in someone else's name (unless you co-signed, which is a whole 'nother can of worms). If the person who owes the debt is your spouse, however, the same rules don't always apply. Whether or not bill collectors can legally force you to pay off spousal debt depends on whether or not you live in a community-property state.

Community Property States and Spousal Debt

Only nine U.S. states follow community property laws. Those states are as follows:

  • Arizona
  • California
  • Idaho
  • Louisiana
  • Michigan
  • Nevada
  • New Mexico
  • Texas
  • Washington

Because community property laws exist primarily to make the division of property in a divorce a simpler and fairer process, this statutes generally applied to assets rather than to debts. Community property regulations may apply only to certain debts or only under state-specific circumstances. Don't assume that community property laws are identical in every state. They're not.  We're going to use California as an example here because California's spousal debt statutes are clear – if your spouse owes it, you owe it.

Do I Owe My Spouse's Debts?

Division of debt typically comes up only in legal separation and divorce proceedings. When a creditor or collection agency decides to sue, however, who they can sue depends upon the community property laws in the debtor's state. Unfortunately, knowledge of the debt is not a prerequisite to payment. In other words, you're legally responsible for paying off the debt whether you know about it or not. Lets look at the following example:

Suing the Spouse and Not the Debtor

In a state that applies its community property statutes to debt as well as assets, a collection agency has the option to either pursue the debtor directly or pursue his spouse. Most companies will pursue payment from the debtor first as a matter of policy. If the debtor lacks the assets to pay or is considered "judgment proof," bill collectors have the option to pursue the spouse. Lets look at an example of this in action:

Lisa and Joe live in California. Joe lost his job and currently receives unemployment. He has not found work yet. Although Lisa has a stable nursing job, the two are struggling financially and Joe defaults on his credit card. He knows that the credit card company is unlikely to sue him since he does not have wages the company can seize. Because the account is in Joe's name only, he assumes his wife's wages are exempt from garnishment. To the couple's surprise, the credit card company sues Lisa. Even though her name is not on the account, she is still liable for the debt under community-property law.

Domestic Partnerships and Community Property Law

California recognizes domestic partnerships in addition to traditional marriages. This gives many of the same benefits (insurance, inheritance rights, etc.) to those in a domestic partnership that married couples receive. Unfortunately, the downsides of marriage also apply.

Domestic partners are also liable for spousal debts under community property law. Granted, its not phrased that way because domestic partnerships are not classified as marriage (although I firmly believe that this can and should change. It's only a matter of time). Thus, a domestic partner can also be held responsible for debts that were incurred by his partner.

The Exception to Community Property Debt Responsibility

The exception to the community property rule that applies in all community property states is that an individual cannot be held liable for his spouse or domestic partner's debts if those debts were incurred before the couple  entered into their union. For example, if your spouse has outstanding student loans that were never paid and the two of you married after college, you aren't liable for those defaulted loans – regardless of whether or not you live in a community property state.

Sunday, February 19, 2012

What Is a Key Derogatory on Your Credit Report?

Finding a key derogatory on your credit report is no walk in the park. Derogatory information lowers your credit score and makes you a greater risk for lenders. Negative entries generally fall under the heading of public records or collection accounts. Because not all negative reports fall under the category of key derogatories, there seems to be quite a bit of confusion regarding what a key derogatory actually is.

What is a Key Derogatory?

A key derogatory is typically any entry that is both negative and affects your credit scores. You're probably thinking, "But Lee, don't all negative entries affect my credit score?" Surprisingly no, they don't. Let me explain.

A key derogatory is nothing special.
The FICO scoring system is designed to help lenders make the most accurate lending decisions possible. Not all negative information makes you a greater risk for a lender. For example, if your credit report reflects a defaulted credit card debt of $1000, you're automatically a higher risk for any lender. After all, if you defaulted on that debt, you are more likely to default on another debt in the future. By contrast, an unpaid parking ticket for $40 has little – if any – bearing on your debt management skills. It's just as likely that you simply forgot to pay the ticket as it is that you intentionally refused to do so.

Fair Isaac updated its FICO system in 2009 (Yeah, its called FICO '08, but Fair Isaac was a year behind schedule in releasing the update) to better manage derogatory information. Derogatory credit entries for less than $100 have a reduced impact on your credit scores. In some cases (such as the parking ticket mentioned above) these derogatory entries do not impact your credit scores at all. By preventing small and relatively insignificant debts from dragging down your FICO scores, Fair Isaac helps prevent lenders from losing money by refusing to lend to an individual who would be likely to repay what they borrow – plus interest.

Key Derogatory From Experian

Unlike TransUnion and Equifax, Experian has a different method for determining which entries are and are not key derogatories. A negative entry must fall into one of several specific categories for Experian to mark the entry as a key derogatory. A key derogatory from Experian must be one of the following:

  • A government debt, such as an unpaid student loan
  • Term default (defaulting on the payment terms of a contract, such as mortgage default)
  • Bankruptcy
  • Settled debts (this includes short sales)
  • Unpaid claims (collections, etc.)

This encompasses most, but not all, forms of derogatory entries that may appear on your credit report.

Derogatory and "Key Derogatory" are Synonymous

It is up to the individual credit bureau what does and does not constitute a key derogatory. The negative affect on your credit score is the same regardless of how the credit bureau chooses to label the entry. In this regard, a key derogatory is not any different from a standard negative trade line. Should you file a dispute, you can do so regardless of whether the entry is a key derogatory or a run-of-the-mill credit blemish.

The good news here is that you are the only one who can see what is and is not categorized as a key derogatory on your report. The credit reports that lenders pull are structured differently than consumer reports and do not separate negative entries into "derogatory" and "key derogatory" categories.

Friday, February 17, 2012

Can a Collection Agency Come After a Minor?

A contract isn't always legally binding
Just about everyone has heard horror stories about children and teens who carry a dismal credit record because a collection agency pursued them for a debt while they were still a minor. If you are a minor and debt collectors are harassing you, you generally have more secure rights than a legal adult facing the same problem.

Minors, Collection Agencies and Contracts

In most states, minors cannot be held responsible for contracts they sign because a minor is not legally capable of entering into a binding contract. Let's look at this in regards to credit card debt.

Judy is 16. A credit card company sends Judy a credit card application (against the law per the CARD Act, but that's irrelevant to the point here), she fills it out, sends it in and gets her new credit card. Judy doesn't manage money well and defaults on the payments. The original agreement that Judy signed with the credit card company gave the company the right to pursue collection activity against her in the event she defaulted on the debt. Because Judy is a minor, the credit card agreement – and the debt she incurred on the card – may not be legally enforceable.

This isn't to say that Judy won't have a fight on her hands. The collection agency does not want to be told that it can't collect and will go out of its way to make sure that Judy pays. Judy's parents will likely need to hire an attorney to draft a letter to the collection agency notifying it that continued collection activity is against the law.

Adult Co-Signers Responsible for Minor's Debts

Parents are generally responsible for teens' debts
In most cases, minors are protected from Judy's situation. The vast majority of merchants will require a minor to have an adult co-signer before providing the minor with a contract. This gives the creditor someone it can legally pursue in the event the minor does not pay the debt. For example, if Judy's parents had to co-sign with her for the account, the credit card company and collection agency would doggedly pursue her parents for payment – not her.

Emancipated Minors and Debt Collection

A minor can gain the ability to enter into a legally binding contract by becoming emancipated. Emancipated minors have all the rights and responsibilities of a legal adult. If Judy was an emancipated minor, she would have the ability to sign a binding contract with a creditor without having a co-signer. Because an emancipated minor is bound just as tightly to the contracts she signs as an adult, a collection agency can pursue the individual for payment using the same methods it uses to collect from adults.

Voidable Contracts for Minors

Now, here's where things get slightly complicated. Remember when I said minors can't enter into binding contracts? That the technical side of things. The contract isn't technically void until its voided by the minor. It's simpler than it sounds. Lets look at the example from a different angle:

Judy loses her job at the department store where she works after school and knows that she cannot afford to make payments on her credit card. She writes the credit card company a letter informing them of her age. She sends a copy of her driver's license with the letter to prove that she is, in fact, a minor. Judy notes in her letter that, because she is a minor, she is voiding the contract she signed with the credit card company. The credit card company has no choice in the matter and must terminate the agreement.

This does not mean that the credit card company won't still pursue Judy for what she owes. It will, but it will likely wait until Judy turns 18 to do so.

All of this comes into play because the credit card company knew that Judy was 16 when she applied for the card. Had she lied about her age and claimed to be 18, the situation gets more complex. State laws vary, but lying to a creditor in order to obtain an account as a minor is a clear case of fraud. In that situation, a creditor or collection agency would likely be able to pursue the cardholder for payment regardless of whether or not the debtor is a minor.

Saturday, February 4, 2012

Improving Credit Scores After Collections

Improve your credit scores
I keep getting questions from readers wanting to know how to improve their credit scores after collections show up on their credit reports. Because lets face it, paying off the collections doesn't remove them from your credit report nor does it improve your score. So what do you do?

Before I go into any depth here, I want to point something out: This is where I got my start. This is my home turf. Working as an activist for consumer rights against debt collectors came later. Credit – and making it better – is where it all began. Ah, the memories...

Anyway, back to the issue at hand. You have several options.

Option #1: Dispute Paid Collections With the Credit Bureaus

This is a very "maybe" course of action, but if you're working on cleaning up your credit anyway, it's worth a shot. Now, the legality of disputing accurate information is a gray area. I am not advising anyone to dispute accurate information on a credit report. If, however, you discover errors in the collection agency's trade line on your credit report – no matter how minor that error may be – disputing the information is an option.

In most cases, when a person disputes credit information, the credit bureaus contact the information furnisher (in this case, the bill collector) and say, "Hey, is this right?" and the information furnisher says, "Yep, sure is." and its game over for you. Is this ethical? Heck no, but its how the game is played. The advantage you have here is that, once the debt is paid, the collection agency really has no incentive to respond to the credit bureau's inquiry. If they don't respond within 30 days, the trade line vanishes and your credit improves.

Option #2: Pay Down Some Debt

Your credit score (and when I say "credit score" I mean "FICO score" because no other credit score matters) is made up of a variety of different things. One such factor is your debt-to-limit ratio. Some also refer to this as your credit utilization ratio. Basically, this ratio is the balance of how much revolving (credit card and HELOC) debt you owe compared to your limits on those accounts. The larger the gap, the better your credit score will be. For example, a person who has one credit card with a limit of $1000 and only owes $50 is in a lot better shape credit-wise than a person in the same situation who owes $500. If you can afford to pay down some of your credit card or HELOC debt, that will help you quite a bit.

It seems like everywhere I look, I see "experts" telling consumers to keep their credit card debt below 30%. Doing that will provide your credit with some measure of protection, but if you're trying to improve your credit scores, you need to go much lower. Ideally, a person hoping to improve his or her credit should carry a balance between 5% and 9% of the credit limit. It isn't necessary to pay the card or line of credit off each month.

Where did I get that number? Simple. I've spent years using my own credit as the guinea pig for my theories. In my experience, this is the ideal number.

Option #3: Become an Authorized User

This one won't work for everyone, but if you have an immediate family member with great credit and a credit card, its the way to go. Just ask your family member to add you on to his/her credit card account as an authorized user. The card information then appears on your credit report and – provided the primary card holder is an immediate family member – it factors into your scores. You can become an authorized user on any account, but it won't help your scores unless that person is someone whose card the credit bureaus can be reasonably certain you would actually use, like that of a parent or spouse.

Try to avoid secured credit cards if you can, and it should go without saying that you should pay all debts on time. I'd write more here, but I'm falling asleep at my desk...

Related Posts:

What to Do When a Collection Agency Validates Your Debt

Death of the Pay for Delete Agreement

Deleting Collections From Credit Reports With the "One-Two" Punch