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.

Photo by SuziJane

First, Count Up Your Total Indebtedness and Monthly Income

If you do not already know how much indebtedness you have, not counting your mortgage, then you need to sit down and total up all your debt. In addition, you need to find out how much total income you have – after taxes. This will show you what kind of money you have each month once you subtract monthly bills from monthly income. If your income is less than your monthly debts, then you will need to act quickly to make some immediate changes.

This prospect might seem a little daunting, but it’s really not all that difficult. You can do it old-school, with pen and paper, but I prefer the mod cons, so I use a budget planner spreadsheet. Get a ready made one here, as well as instructions on how to get it working (it’s an American site, but the info is good for Aussies too).

Consider Your Debt Reduction Options

If you have a lot of credit card debt, and not other kinds, then you may be able to obtain a new balance transfer credit card. This kind of credit card is valuable to you if:

• You do not put new charges on the old cards
• You are able to transfer debt without charges – or minimal charges
• You will reduce your charges as fast as possible while you have 0% interest.

Consider a Debt Loan

Taking out a debt consolidation loan to pay off your other loans can be a very good idea, although it will not work to everyone’s benefit. It will help you if:

• Your current loans have high rates of interest.
• You can get a lower interest rate and longer terms.
• You have an income that will enable you to meet payments comfortably.

In order to be considered for a debt consolidation loan, you will find that a lender will more readily work with you if you have some assets – a secured loan. Secured loans are obtained more readily because there is some collateral behind it. Don’t forget about the possibility of refinancing your loan, too.

Let Debt Consolidation Work for Your Lasting Good

Getting a new loan for debt consolidation will work best for you if you will work to pay it off as quickly as possible. Doing so will help raise your credit score if it has been hurt because of the debt and missed payments. Ideally, you would want to get a debt consolidation loan before that happens.

You want to avoid letting this new loan take its full course. It is to your advantage to pay it off quickly in order to avoid as much interest as possible. This will enable you to get out of debt quicker and enjoy the freedom of being debt free again. Debt consolidation loans work best if the end result you seek is total debt elimination. Anything less should not be looked at as a lasting solution.

Talk to Debt Counselors

Most people probably do not need to talk to debt counselors, but in some cases it will be necessary. This may be an especially good idea if:

• Your debt exceeds your income
• You have no idea what to do
• You do not handle money well
• You are considering declaring bankruptcy.

You can get the help with your debt that you need. The first step is to see where you can comfortably reduce your monthly expenses and put that money toward your existing debt. Oftentimes, with good money management and a tightening of the belt, you may be able to slim down your budget and eliminate debt on your own – although it will not happen overnight.

Photo by restlessglobetrotter

Either your financial burdens will lighten, or they will reach a newer, more crushing weight too difficult to withstand.

Very few people who pursue debt consolidation end up in the middle.

Such extreme results are common with debt consolidation. And finding yourself on the downside of the process is, unfortunately, much easier than breaking free of nearly insurmountable debt.

Debt consolidation is based on a simple principle. Rather than issuing multiple payments each month to multiple creditors with whom you owe substantial sums of money accruing equally substantial interest, debt consolidation amasses all debts owed into a single bundle tagged with a lower interest rate and customized to allow for smaller payments over a longer period of time.

In theory, this arrangement sounds like a terrific opportunity. And while it can be under the right conditions, many individuals who pursue a consolidation opportunity quickly discover the dark side of debt consolidation.

The Concerns with Consolidation

Despite heavy media campaigns to engrain the opposite message in our collective psyche, debt consolidation loans offer no immediate, universally advantageous, or guaranteed win-win situation. Of the many potential drawbacks to obtaining a consolidation loan, some are more persistent and perilous than others.

• Obtaining a debt consolidation loan (i.e., continuing the practice of borrowing) usually does little if anything to curb overspending, the problem that got the borrower in trouble to begin with.
• Consolidation loans, ironically, can be exceptionally more expensive than the debt they are supposed to help repay.  Because of hidden fees, early repayment penalties, and administrative expenses, obtaining a consolidation opportunity could prove a costly decision over time.
• Debt consolidation has become an industry comprised of many unscrupulous representatives that thrive on people who are prone to financial miscalculations and are taking up yet another loan to battle back against previous debts. In this regard, consolidation loans often serve to merely perpetuate a worsening cycle of debt.
• A high percentage of consolidation loan recipients use their loan to pay off credit card balances but once again max out their various lines of credit before their consolidation loan has been fully repaid.

Although there are myriad steps one can take to reduce their chances of having a negative experience in debt consolidation (shopping around for a competitive loan and rate, checking loan providers for a history of integrity, etc.), the most advantageous aspect of delving into the surprisingly complex and confusing world of debt consolidation is having a learning experience of a lifetime.

Whether it works for you or not, the process of researching (and potentially securing) a debt consolidation loan will, if nothing more, prove an invaluable education in capable money management.

With a proper understanding of skilled financial stewardship, a debt consolidation loan can be an effective, minimally dangerous tool useful for correcting financial transgressions and crises of the past. But it remains vitally important to use any consolidation opportunity to change your money management techniques in order to avoid becoming one of the seven in ten who still remain in debt after repaying their consolidation loan.

Photo by Chris Isherwood

Who Needs a Debt Consolidation Loan?

Debt consolidation loans are primarily intended for individuals or families struggling to manage any form of outstanding debt:

• Credit card debt
• Personal loan debt
• Mortgage or housing debt, etc.

Despite sounding like a highly attractive option that, based on incessant advertising, seems widely available, obtaining a quality debt consolidation loan can be more difficult than one would expect.

Why?

Let’s face it, how many legitimate lenders want to invest in someone who has already gotten into such a tremendous financial predicament? As result of the difficulty born of getting an established, trustworthy company to issue a debt consolidation loan, many desperate borrowers unwittingly find short-term comfort and long-term pain in shady lenders that eventually lead to even more financial problems for down-and-out debtors.

Unfortunately, there is no shortage of surprisingly common debt consolidation mistakes that borrowers make when in the market for this particular financial product.

Avoiding The Dangers of Debt Consolidation

• Hidden Fees. Debt consolidation loans can often be packaged with exorbitant hidden fees and administration costs. Apart from the interest rate you secure, which may depend in large part on your financial history, there are typically processing fees, monthly service fees, and even a fee for each payment sent to your creditors. There is also a vast fleet of companies that actually charge a penalty for paying off your balance early. Be sure to read the fine print and know that every cent you provide pays off more of your debt than your loan provider’s “administrative fees.”

• Old Habits Die Hard. A debt consolidation loan can reduce the onerous process of paying multiple creditors every month. Unfortunately, many confuse a debt consolidation loan for a new beginning. In reality, your debt remains unchanged. Yet, because previously maxed-out credit cards and other lines of credit are now reduced to zero, without great caution, a reckless spender could soon find himself in an even worse position than before – with a debt consolidation loan and a new batch of bills created outside of it. Securing a debt consolidation loan is anything but a license to spend again.

• Trust But Verify. There are thousands of debt consolidation companies that want your business. Many should be avoided like the plague. How do you know which are legitimate, credible agencies? You won’t without conducting adequate research. Never, under any circumstances, take a company’s counselor at his or her word. If they claim to possess any licenses or registrations for conducting business, ask to see them. Apart from shopping around for the best financial arrangement possible, it is doubly important to double check everything you’re told and everything you read so that you know exactly how your debt consolidation process will play out in full.

The Most Important Lesson

Ultimately, no matter how successfully one sidesteps the common pitfalls of debt consolidation, what guarantees that a first loan of this nature will also be the last is seriously addressing the situations, lifestyles, or issues that led to the need for a debt consolidation loan in the first place. At the end of the day, it is just as important for the debtor as it is the creditor to take accountability and responsibility.

Photo by shoothead