Let’s look at some advantages and disadvantages of borrowing from family and friends:

Pros:

• Low interest rates, if any
• Instant access to money
• Banks are tight, only means to obtain funds

Cons:

• Relationship is jeopardized if loan is not paid
• Financial situation is no longer private
• No protection due to not being formal

Financial transactions between people with personal ties tend to muddle a relationship. What once was purely a friendly or familial connection now takes on elements of a business transaction.

Furthermore, very few use business contracts and documents to formalize the transaction. Because of the relationship, the lender becomes uncomfortable laying out the agreements formally. They do not want to “taint” the emotional relationship.  This, of course, just leads to bigger problems.  Life happens (lay-offs, natural disasters, etc.) and without formal documentation, both the lender and borrower are not protected when these events occur.

In October of 2008, The New York Times published an article entitled Mixing money and family in the US where the author, Christine Haughney, demonstrated that loans between family members has increased since the banks have tightened their lending standards.  For many young adults, the only way they can purchase a home/car or get out of debt is to borrow from relatives.

While the pros and cons are neck and neck, it should be noted that each of the cons weighs a bit more than each pro because of the emotional relationships involved.  But several sources list guidelines that help lessen the impact of the issues addressed in the con category.

One of the most common guidelines when mixing “love & money” is to not make it a loan.  If you, the lender, make a financial gift, then there is no expectation of repayment.  Thus the relationship is not strained.

The other most common guideline to loaning/borrowing from friends or family is to document, document, document!  There are inexpensive (and some free) loan document templates available online that individuals can use to keep the whole loan on the “up and up,” such as Net Lawman and Law Depot.

If you do decide to ask for money or loan money, here are a few things to consider:

For the borrower:

• Borrowing should be the last resort (eliminate all non-essentials in your life)
• Gauge the risk of the loan coming between you and your family
• Figure out exactly how much money you need before asking
• Prepare a budget to determine how much you can comfortably pay each month to repay the loan
• When you ask the family member or friend, spell out exactly what the money will be used for and provide financial documents that show your income and expenses to prove you can repay the loan
• Prepare a formal loan document that spells out the terms of repayment and remedies for default in the loan
• Do not expect special treatment.  This is business.
• Avoid wastefulness while the loan is outstanding

For the Lender:

• Make a gift instead of a loan
• Don’t lend money you can’t afford to lose or do without
• When possible, gift/loan needed items instead of money
• Make sure your family member or friend is able to make monthly payments to pay you back
• Prepare a formal loan document that spells out the terms of repayment and remedies for default in the loan
• Don’t co-sign for anything unless you are prepared to pay off that debt yourself.  If you have co-signed, keep track of the payments that have been made
• Do not expect special treatment.  This is business.

Ultimately, each person will have to weigh the pros and cons of borrowing/lending to family members or friends and make their own decisions.

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Since rampant debt and the subsequent repayment can ruin lives, we thought we would take a look at some debt management strategies to help you get a handle on your debt.

Make Minimum Payments

This is the debt management strategy that the credit card companies and banks want you to take and it is one of the most popular today, unfortunately. You make the minimum payment on all of your accounts each month, and eventually, at some nebulous point in the distant future you will pay them off.

It takes THIRTY YEARS or more to pay off a credit card making only minimum payments. That’s because monthly payments are determined as a percentage of the outstanding balance, typically between two and three percent. As you slowly pay down your balance, the minimum keeps going down and you pay less and less of your balance each month which keeps you paying interest for years to come. A good bit of business for the credit card companies but a bad idea for you. Really bad.

Debt Snowball

With the debt snowball method, you make a list of all your debts and order them from highest balance to lowest balance. Then you make minimum payments on all of them except one. On that balance you throw every bit of spare cash you have, above and beyond the minimum payment.

Once you pay it off, you move on to the next debt on the list and keep paying extra on it until it is gone. The key here is to not absorb the payments you were making on the now paid off balance into your living expenses. Turn around and apply all that money to the next debt and whack it into submission.

What makes the snowball so powerful is that your amount of money available to pay down your debts increases as your total debt load goes down.

There are three ways to decide which debt to pay off first.

1. Interest Rate. By choosing to pay off the highest interest rate debt first, you will save money in the long run by not paying all of that interest while you pay off other, lower interest rate accounts first.
2. Balance Due. Many people choose to pay off the smallest balance first, because it proves that they really can do it, and it is easier to pay off $1000 than $10000.
3. Emotional Satisfaction. Some of you just have it, a debt that makes you irrationally mad. Maybe you guaranteed a card for an ex, and now you are stuck making the payments. Whatever the reason, paying off this debt first would give you a big mental boost, so do it.

Slow and Steady

Make a list of all your debt and the current minimum payment. Using this method you will make the same monthly payment as you are on the day you make your list. As we said before, minimum payments go down in proportion to your balance, with the ultimate goal of keeping you paying interest for a lifetime.

By continuing to make the same payment each month you will pay off your debt in seven or eight years, ten max.

Emergency Fund

All debt management coaches and plans will prescribe saving an emergency fund before you begin trying to repay your debt. Save at a minimum $1000 and keep it for real emergencies, not just a sale at the local clothing store.  Some people recommend saving up to one full month’s expenses.

Having an emergency fund will let you pay for things in cash, without relying on a credit card, which provides a tremendous boost to your debt paying psyche.

Emergency funds make for a good management tool even when you aren’t in debt. Try building up a fund of easily accessible money that is equal to six month’s salary. This will allow you plenty of freedom and the ability to meet almost any emergency head on and pay with cash.

Irregular Expense Fund

Similar to an emergency fund, this is an account where you save money for expenses that aren’t monthly. For example you could create a tire fund and place money in it to prepare for purchasing a new set. Car and home maintenance are other examples of categories that you could include in your irregular expense fund.

The key here it to estimate how much you will need for the year and save until you reach that amount. As you dip into the irregular expense fund, pay it back until it is replenished.

Closing Thoughts

Most people combine elements, either an emergency fund with the slow and steady approach or an irregular expense fund and emergency fund coupled with a debt snowball. The choice is yours to make, and one way or the other won’t make a huge difference as long as you decide on a strategy, implement it and carry it out.

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Who Should Not Apply

Those people that should stay away from bad debt loans include the following:

• Those that have a lot of outstanding debts
• Those that can gain a better loan rate elsewhere
• Those that do not have a plan to repay a bad debt loan
• Those that plan to use bad debt loans as a form of long-term financing

If you fall into any of the categories listed above, it is best to seek another way of finding the funds that you need. If you are seeking a bad debt loan for another reason, then you may find that this type of loan is exactly what you have been looking for.

Why Apply For a Bad Debt Loan

Believe it or not, bad debt loans can actually help you rebuild your credit. If you want to patch up your credit, or start building it up again from scratch, a bad debt loan is a great idea. Why? If this type of loan is paid in-full on time, your diligence will reflect positively on your credit record.

In addition, if you cannot find extra funds anywhere else, applying for a bad debt loan can help. Often, people that have declared bankruptcy in the past may not be able to obtain a personal loan. In this instance, a bad debt loan can come in handy.

The other reason why bad debt loans may help you is if you simply cannot pay your bills one month. Everyone goes through tough times, but it’s not a good idea to skip a bill payment. If you find that you need to make a payment, but you don’t have any cash, you can gain the funds you need through a bad credit loan.

Things to Think About

It never hurts to be extra careful when it comes to borrowing money. If you find yourself contemplating a bad debt loan, make sure that you run down the following checklist first.

• Look at every other loan option
• Read the loan fine print – are all the terms clear?
• What happens if a loan is not repaid on time? Are you penalized?
• Can you pay back that loan on time?
• Are you choosing the best bad loan offer out there?

Once you have gone through all of these questions, you will be better poised to apply for a bad credit loan. Clearly, bad credit loans aren’t always a bad choice, though they won’t work for everyone. Before you apply for any loan, make sure that you shop around – there are hundreds of bad credit loan companies out there, but only a few of them are worthwhile.

Photo by Thomas Hawk

This is business

No matter where you get your loan, the lender you use is only lending you the money to make a buck (or many) off of you. While most decent businesses will be honest about the costs (This is a legal requirement), it is not in their interests to tell you where to go to save a few hundred dollars.

Considering this, you should definitely shop around when looking for a personal loan company. While most personal loans do not have a payback term as long as a mortgage, you do not want to be a month into a five-year loan, only to find out the company around the corner is offering the same deal at a better rate.

Is the Company Reputable?

You do not want to deal with a “cowboy” operation that makes huge promises, gives you the money then starts charging all sorts of arrangement and admin costs that have been written into the fine print. Ask yourself:

- How long have they been operating? Yes, just because a company is new doesn’t mean it isn’t reputable (and vice versa), but it’s always worth checking into the company before you take the plunge.

- Do you know anyone that can recommend this company? If someone you know used the personal loan company and had a good experience, chances are you will do well with them too. Many companies are quick to offer testimonials from happy customers, but these will be edited to show the company in the best light possible. You may consider speaking to someone like ASIC (http://www.asic.gov.au/asic/asic.nsf) regarding the company if you have any doubts.

Does the personal loan company do secured or unsecured loans?

- A secured loan is called ‘secured’ as you use collateral that you pledge to give the personal finance company if you don’t pay back the loan. If the money lent is for a mortgage, the collateral is your home. With a car loan, you risk losing your car. With a personal loan, you might pledge something already mentioned, or perhaps another expensive item – Jewellry perhaps.

- An unsecured loan is similar to credit card debt, as there is no collateral to cover the personal finance company’s investment if you do not pay the sum back. This does not mean you will get away with missed payments however; the company will often get you back with late fees and so forth – Plus it can damage your credit rating.

How will your credit standing affect the loan company’s desire to do business with you?

If you have a bad credit rating, or even no credit history at all, some companies will not even humour you. Other companies, however, will be happy to take you on, albeit at a higher than usual interest rate.

-Another possibility is that the company will ask you to have a cosigner on the loan – If you’re young and have poor or non-existent credit history this is likely. What this means is that the company aren’t happy with just your assurance that the loan will be repaid (Which is essentially what your signature is on a loan application). The cosigner will also need to sign the loan documents, ensuring the company that they will pay back the loan if you default on it. Many people will not (or can not) cosign a loan however, as it is a massive financial responsibilty should you default on the loan.

Unfortunately, there are no absolutes when dealing with life, and that includes getting a personal loan. However, if you keep these recommendations in mind, ask any questions you have (no matter how dumb they may seem) and verify every step you take, then getting the money you need should be relatively painless.

Photo by Daniel Y Go

1. A Payday Loan is a type of short-term loan

   For the most part, all you will need when applying for one is a checking account, a steady source of income, and a valid ID.  It does not require a credit check.  Most loans are for a period of between 7 and 62 days.

2. Interest Rates are higher.

   Because payday loans do not require a credit check (in most cases) before the checks are cashed, the companies compensate for the problem by hiking up the interest rate.   Some of these rates may be up to 1300% per annum – so that loan you take out for $300 could wind up costing you $3900.  Ouch!

3. Repeat Customers keep payday loan companies in business.

   That’s right, like the couple I know, most people who apply for a payday loan find themselves needing to apply for another – and another, thus continuously driving themselves further into debt – and at that high rate of interest.
   

4. Those most likely to request payday loans tend to be low-income.

   This means they are less likely to have an emergency fund set aside.  When unexpected expenses hit, they often fall prey to the payday loan cycle.  The best way to avoid the payday loan cycle is to avoid taking out a payday loan in the first place.  Set aside a portion of every paycheck for an emergency fund.

5. In May 2009, new legislation was proposed in Australia governing payday loans.

   This law will advocate licensing procedures that requires lenders to also provide information on payday loans to borrowers at the transaction’s initiation.  It will also require credit checking – intended to help keep consumers out of trouble by keeping them from taking on more debt than they can pay back.

6. In the United States, payday loans have been banned in 11 states.

   The New York Times profiled a man who spends $1500 a month just paying the interest on payday loans.  The cycle is vicious, and government officials over the world are beginning to catch on to how predatory these lenders can be.

7. Because the loans are easy to get, you can wind up in trouble faster than you expected.

   Most people don’t expect payday loans to become a permanent solution, but because of the astronomical fees associated with the loans, wind up becoming dependent upon the system just to barely keep their noses out of the deepening debt waters.

8. Payday Loans should be a last resort.

   This is why establishing an emergency fund is so important.  If you have no assets that can be liquidated should a crisis come along that requires money you don’t have, you have no one who can lend money to you, and all other options are also exhausted, then get a payday loan.  Payday loans should never be used because you paid your bills and don’t have anything left over for buying that new video game system.  For ten alternatives to payday loans, you might want to read “10 Options to Consider before Getting a Payday Loan” by Trent at The Simple Dollar.

What happened to the couple I knew?  They eventually crawled their way out of the hole with help from family and friends – and a part time job.  For a while, however, it did put a strain on their relationship due to having constant financial stress hanging over their heads.  And both of them wished they had been more informed about the perils of payday loans before signing.

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The existence of compound interest speaks to the latter. And it’s exactly why compound interest is one of the safest, most effective mechanisms for growing wealth in existence.

Albert Einstein called compound interest the “greatest mathematical discovery of all time.”

But fortunately, understanding and capitalizing on compound interest doesn’t require the mental capacity of a genius like Einstein.

What is Compound Interest?

Compound interest occurs when you add accumulated interest back to the principal. As a result, interest is earned on interest on a perpetual basis thereby increasing your overall investment amount exponentially over time.

Although you can quite easily use a compound interest calculator to input the values unique to your financial situation, here is just one example of the awesome power of compound interest:

If you save one hundred dollars each month for forty years and your investment compounds at 12% annually, how much will you have? $980,000.

How Compound Interest Works

Compound Interest is often likened to the snowball effect. As your investment rolls down the hill it grows at an accelerated pace. Even with a small snowball to begin with, an exceptionally large one will result over time.

Compound Interest is based on two variables – the length of investment and the rate of return. Simply put, the longer your money is left to grow, the faster it will balloon. Similarly, the higher the interest rate you earn on your money, the higher the invested amount will become over the duration of the investment.

If you’ve ever wondered why it seems easier to stay rich than it is to become rich, it’s largely because of this mathematical phenomenon known as compound interest.

Yet, even if you are not already independently wealthy, there are simple steps that can be taken to yield big returns in the long run. For example, most people spend at least one dollar each day on some form of refreshment. Over the course of one month, however, if each dollar is directed instead to an investment account accruing compound interest at an 8% annual return, after a forty-year period elapses, you will have earned a whopping $101,372.91.

The only potential drawback associated with making compound interest the centerpiece of your investment strategy is that the rate of interest may not be the same every month. And because the rate may fluctuate (5% the first month, 3% the next month, etc.) a lot of investors still prefer to maintain the more stable and consistent – yet lower rate – of return by foregoing compound interest and, in its place, keeping their money in a simple savings account.

Making Compound Interest Work for You

Compound interest doesn’t work overnight. Throughout the duration of your investment, it is pivotal to patiently add, not withdraw from your investment if you are going to experience the awesome power of compound interest in full.

By working hard and having your money work hard for you, the path to fiscal strength and lifelong solvency will be clear and much easier to follow.

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Here are 10 tips to help you avoid the dreaded ‘B’ word.

Stop spending

As shocking as it may be, many people on the road to bankruptcy never stop spending money. Clamp down on all unnecessary expenses and even cut needed ones to the bone. You can live on plain pasta and rice for a while. Don’t even worry about a budget right now, just stop spending money.

Prioritize debts

At some point in the future, you may wind up defaulting on a loan or credit account. Sit down and prioritize the debts that you have in the order of which one will I pay first down to which one will I pay last. Mortgage and car payments should rank at the top of the list.

Sell assets

Cars, houses, stocks, anything that can bring in a decent hunk of change. If you live in a metropolitan area, chances are you can make do for a while using a combination of public transportation and your feet.

Contact creditors

Call all of your creditors and explain to them that you are in deep financial straits and confirm your commitment to pay them. This lets them know that things aren’t going great for you right now and that you are concerned about paying them back. Record the name and conversation details of everyone you speak with.

Negotiate new terms

Talk to each creditor again, and try and get them to reduce interest rates or minimum payments. For loans try and have the installments extended so that you can lower the monthly payments. See if they will let you skip a payment or two and just add the interest to the balance. It is important to do this after the first contact so that it isn’t the first time they hear from you.

Negotiate settlements

Call each creditor again and try and get them to accept a settlement on the debt you owe them. This is actually two steps, since you will want to do it again after step 9. I know it seems like you could accomplish steps 4-6 in one call, but persistence can pay off and you may not need to do the same thing with each creditor. Some may offer to work with you right away, and others may need some prodding. You may find that skipping a few payments is all you need from some creditors and on others you will need a settlement to be able to stave of bankruptcy.

Seek a consolidation loan

While I don’t recommend them, consolidation loans can be a last ditch effort to stave off bankruptcy by getting all of your accounts current and reducing your overall interest rate to lower your monthly payment.

Seek credit counseling

Sometimes credit counseling services can actually get your interest rates severely slashed or even suspended in order to facilitate payback of the principal.

Default on low priority debts

Letting go one or two lower priority debts can free up some cash to focus on other debts. This is a desperate step, but it can keep you out of bankruptcy. Be sure to call any accounts that you default on and try and work out a settlement. If not, you can repay the debt later when you are on more stable financial footing, only you will most likely be dealing with a debt collector by then.

Seek an ITSA agreement

The Insolvency and Trustee Service Australia is the government entity that deals with personal bankruptcy proceedings in Australia. They provide three manners to deal with unmanageable debt, and two of them, a Debt Agreement and Personal Insolvency Agreement, stop short of bankruptcy. Their website is full of information on both of these options as well as links to agencies that can help you avoid bankruptcy.

Conclusions

These steps are not really designed according to long-term financial prudence, as several of them will wind up adding to your overall debt situation, but they may be able to free up enough room to keep you solvent right now and that dictates your main course of action right now. Once you escape the immediate specter of insolvency, you can work on managing the debt better.

Bankruptcy is an ugly thing to go through so don’t give in just because it seems like you have no choice. In most cases you can avoid bankruptcy if you work at it. I cannot stress enough the need to call and negotiate with your creditors. With today’s financial climate and rates of default, lenders are more willing than ever to help you pay them back. And while it will be a struggle, paying them back is the best thing you could possibly due.

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This free service to help you manage your financial situation is debt counselling, and as a broader field, financial counselling. Debt counselling allows you to meet with a financial counsellor who will assist you with getting your finances back on track. While it may seem impossible to turn around now, your counsellor will work with you to change your financial future.

Are Counsellors Qualified To Help Me?

Financial counsellors are available in every state and territory of Australia; there are over 150 counselling organizations that employ over 500 financial counsellors.  Since these agencies are funded through various levels of the Australian government, they do not charge consumers for their services.

Of course, there are some restrictions as to who can become a financial counsellor. While the ASIC does not require counsellors to be licensed, they must meet certain skill and knowledge requirements and membership requirements. Other conditions include:

• Financial counsellors and the organizations cannot charge a fee or be remunerated for their services
• The counselling organization is limited to this business; they cannot participate in other areas of financial services
• Counsellors cannot recommend or give advice on investment products

Benefits To Debt Counselling

Debt counselling is one service that provides many benefits with literally no financial cost to you; all you need to spend is your time. Counsellors can help you with many things including

• Debt negotiation with your creditors
• Budgeting and financial planning advice
• Exploring debt reduction options
• Determining eligibility for government aid
• Advice on how to improve your overall financial situation

While you can attempt to solve some of your problems on your own (such as Do-It-Yourself Debt Negotiation), a debt counsellor is able to sit and explore every option with you. One of the most attractive aspects of obtaining help from financial counsellor is that you are assured quality assistance with no cost.

One important note: Now that you know about free quality financial counselling, be wary of anyone who tries to sell you the same services for a large fee. Even if the individual is a legitimate financial advisor, you may be able to obtain the same services for no cost.

Alternatives

While there are alternatives to seeking debt counselling, none of them are as comprehensive and helpful as seeking help from a professional. If you are deep in financial trouble, debt counselling can help you with all aspects of your finances from one location. Before you seek any other alternatives for assistance, contact your local financial counselling organization first to see what services they can provide.

For your convenience, FIDO keeps a list of some counselling organizations in Australia, along with more advice on financial counselling and how it can help you. Use this list to ensure that you get help from the right sources. FIDO is also a great resource for tips on how to manage your debt, start a budget, and buy insurance.

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Whether you are taking out a loan or filing for bankruptcy, you will quickly find yourself in a crash course on he subject. But by knowing about secured and unsecured debt before you absolutely have to, there is a better chance that you can avoid many of the financial mistakes made by those who don’t understand either or their relationship to one another.

What is Secured Debt?

Secured debt is surprisingly easy to understand. Essentially, secured debts are debts that are tied to your ownership of some property. Should you default on repaying a secured debt, the lender will have recourse in the form of seizing the property to which you debt was linked. Mortgages are outstanding examples of secured debts because if you can’t repay the loan, the bank that provided the loan can take possession of your house. Other examples of secured debts are loans for the purchase of automobile or even a line of credit to purchase furniture.

What is Unsecured Debt?

Unsecured debt can best be described as the practice of walking a tightrope without a safety net. If you fall, there’s nothing to catch you. From the perspective of a lender offering unsecured debt, this is the best analogy to describe their risk. Basically, anyone who defaults during repayment has no tangible possession to forfeit in return.

Credit cards are a great example of unsecured debt. That is, no collateral is linked to the debt. However, many lenders are beginning to require new cardholders to sign a security agreement that, in the fine print, outlines that your property could be claimed as collateral if the credit card ever falls into default status.

Assessing Unsecured vs. Secured Debt

When taking inventory of personal debt or estimating what you can still afford to borrow, it’s essential to understand the difference between secured and unsecured debt. Some basic pointers:

• Thoroughly inform yourself about any loan you obtain (secured or unsecured). Read the fine print and understand the terms you are agreeing to.

• Don’t forget that secured debt is a loan backed by collateral. What you buy from borrowing could end up belonging to your lender (possibly along with other possessions) if you default on your loan payments.

• Credit card debt and other revolving charge accounts are primary examples of unsecured debt.

• Secured loans often have lower interest rates than unsecured debt.

Ultimately, regardless of your financial situation – strong or shaky – knowing what types of debt you have already accrued and understanding those that you may acquire is an imperative component of lasting solvency and learning how to properly manage debt.

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The Pros

• Lower Monthly Payment – This is the line that hooks most people to the idea of credit card consolidation. If you’re paying $1000 per month, and a company offers you $500, it’s hard to not think that’s a great deal.

• Lower Interest Rate – Especially if you’re going with a secured loan, debt consolidation can give you a much better interest rate on your debt. With a secured loan, you will use your house, car, or bank account as collateral.

• One Monthly Payment – Instead of paying various creditors, you will only need to worry about paying one. It’s easy to keep track of payments and hard to forget about.

The Cons

• The Risk of More Debt – When you choose to consolidate your credit card debt, your burden of debt may feel lighter. Because you feel less burdened by debt, you may be more likely to using your credit cards again, and dig yourself deeper into debt.

• Lose Your Home or Car – If you used your home or car as a security, and find yourself unable to pay back your loan, you can lose your personal property. Be careful, many debt consolidation loans are in fact home equity loans.

• One Monthly Payment – If you have a credit card debt with a higher interest rate, it may be best to pay that off sooner than those with lower interest rates. However, when you consolidate your debt, you cannot accelerate the payoff of one credit card over the other.

• More Money In the Long Run – Although many debt consolidators promise to lower your payments by significant amounts, you term of payment may lengthen. When all is said and done, you could end up paying more.

• You Can Do It On Your Own – Debt consolidation companies are middlemen between you and your debt. Instead of paying them on average 10% of your monthly payment, not to mention the enrollment fees, you can direct that cash toward the debt.

What Does It All Mean?

Debt consolidation may seem like the easiest solution to your problems, but at the end, it’s actually just another gimmick that profits off of you. Consolidation does not remedy the problem, it actually makes your debt worse. If you use a debt consolidator, you are paying them to hold your money for a period of time until your credit card companies give up hope of ever seeing their money from you. Then, the consolidator negotiates a deal with your credit card company, who inevitably accepts. In the meantime, your credit rating lowers. Worse yet, creditors may show derogatory information about you on your official credit score, further damaging your good standing.

For those who choose to use home equity loans, understand the risks before making the leap. Any unforeseen event (an unexpected pregnancy, an illness, a layoff) can throw off balance your carefully orchaestrated finances, leaving your house at risk. If you must take out a secured loan, consider using your car as collateral. Although no one wants to end up in the worst case scenario, it’s cheaper to replace a car than a house.

Photo by Andreas Rueda