The Pros And Cons Of Joint Financing And Debt
There are several reasons why you might consider joint financing debt — from purchasing a property with your spouse to starting a business with your friend. But just because it’s an option doesn’t necessarily mean it’s always a good idea.
Admittedly, many of these situations turn out to be mutually beneficial for everyone involved. After all, pooling your financial resources will certainly enable you to achieve goals you couldn’t on your own. But there are also countless cautionary tails about the perils of mixing money and relationships and the toll it’s taken on people’s credit history, compatibility and long-term financial security.
Like most things in life, there’s no single truth to this question. At the end of the day it’s all about knowing how the up- and the downsides apply for you and making an educated decision before signing on the dotted line.
Pro / Con: Effects on credit rating
This can go either way, largely because your debt will be co-scored based on your respective credit histories. If you’re both responsible with money and diligent at making payments, the net effect on your credit ratings could potentially be positive. However, it requires both of you:
- Always pay your bills on time and in full
- Consistently utilize less than 30 percent of your total available credit
- Don’t have a history of Bankruptcies or Consumer Proposals, and
- Don’t frequently apply for new credit
This is certainly possible, but it’s more likely one of you has a poorer credit history than the other or could potentially end up in a difficult financial situation. In which case, the effects can be detrimental for the other.
Consider a scenario where you’ve joint financed a mortgage with your significant other: At the time, she had a good credit history; but a year or two into the mortgage term, she lost her job. She didn’t have any emergency savings and now struggles to pay her share of the mortgage, has maxed her credit card and missed several payments.
Optimistically, her delinquency and overutilization will only harm your credit rating and make it difficult for you to secure new debt in the future. But it can also cause problems when it comes time to renew your mortgage — affecting your ability to get a competitive interest rate or potentially causing the lender to question whether they’re willing to continue having you as a customer.
Con: Liability for partner’s unpaid debts
It’s important to understand both parties are equally responsible for repaying joint debts. It does not matter who accumulated the debt, nor any agreements about how you’ll divide the payments. In the eyes of the lender (and the courts), anyone on a loan application — whether as a joint debtholder or co-signer — can be the subject of collections action, wage garnishments and court judgements to recover any outstanding payments.
Let’s look at another scenario to understand how this can become problematic:
Imagine you and your spouse have a joint credit card which you obtained for purchases like groceries and other household essentials. You agreed you would only use the card for shared costs and would split the monthly payments equally. Several months later, you realize your spouse has made several personal purchases ¬— maxing out the card — and has not made his share of the payments. You confront him, which leads to an argument and he decides to pack up and leave.
Terrible, right? Well, what’s worse is you’re still on the hook for the debt. You could hire a lawyer to take him to court to petition for his unpaid share of it. But in the meantime, the credit card company will still expect someone to make the minimum monthly payments; and in the absence of your spouse, that person will be you — lest you want to risk seriously damaging your own financial future in the process.
Con: Added strain on the relationship
It’s almost impossible to avoid some degree of co-mingling finances in a relationship; especially if you live with your significant other. You have shared expenses and it’s completely natural to hold one another accountable to common financial goals. However, adding joint debt to the equation can quickly turn healthy concern into unmanageable conflict.
Never enter a joint debt with anyone, be it a spouse, friend or business partner, until you’ve had an honest discussion about your money management habits and can determine whether they’re compatible. You need to establish trust, set expectations and create boundaries around how you will use and repay the joint debt.
Some topics you’ll want to consider include:
- How do you budget and manage your own finances?
- When do you typically pay your own bills?
- How comfortable are you with outstanding debt?
- How comfortable are you with talking about money?
- How conscientious are you about saving money — are you both prepared for a financial emergency?
- How do you feel about and manage impulse spending?
- What are your ground rules for using and repaying the joint debt?
- What guidelines can you put in place to talk calmly and courteously about your joint debt — and prevent the conversation from turning into an unhealthy argument?
If you feel like you’re on the same page after this conversation, you may be able to introduce joint debt into the relationship without too many problems. But remember, it’s not always going to be clear skies ahead. You need to anticipate challenges and be prepared to face them head on when they arise.
Pro: Combined purchasing power may result in a lower total debt and interest rate
Your credit score and record are not the only factors a lender will consider when deciding whether to lend you money and at what interest rate. Two other factors that play into their equation include:
The size of your down payment — i.e. How much money you can give the lender up front towards the principal value of the debt. The higher your down payment, less debt you’ll need to achieve the same purchase goal.
For example, say you want to purchase new boat for $20,000. If you have a down payment of $10,000, the initial principal value of your loan would be $10,000. If you pooled resources with your spouse to reach a $15,000 down payment, the initial principal value would only be $5,000 — a much lower risk for the lender.
Your total earnings potential — i.e. How much you can afford to pay towards the debt each month. The higher your total earnings, the less concerned the lender will be about you potentially missing payments or defaulting on the loan.
Several factors affect your potential interest rate, including how much risk a lender is or is not willing to take on. The more risk, the higher the rate — and the less credit the lender will be willing to extend you. By pooling your resources into a joint debt, you can potentially save a significant amount of money both up front (down payment) and over the lifetime of your loan (lower interest rates.)
Pro: More financial resources to pay the debt down faster
All other factors being equal, combining your resources with one or multiple other people gives you a larger pool of money to draw from to make your debt payments. This usually means you can put more toward the principal value of your debt each month above the minimum required payment — allowing you to pay the debt off faster and reducing the total amount you’ll pay in interest over the lifetime of the debt.
Joint debts therefore have the potential to be less burdensome and less financially overwhelming when approached diligently and conscientiously. However, this only works provided you avoid one MASSIVE trap joint debtholders often fall prey to — inflating the value of your debt to match your increased purchasing power.
Returning to that $20,000 boat for a moment… If you have a combined $15,000 down payment, you’d only need to borrow $5,000 to make your purchase. But perhaps you think to yourself, “I was already prepared to borrow $10,000. Our combined resources mean we could still borrow $10,000 and get the an even nicer boat for $25,000 instead!”
Instead of leveraging your combined resources to get the boat you already wanted and pay it off rapidly, you need your combined resources just to afford the minimum monthly payment. It will take just as long to pay off the debt as if you’d purchased the cheaper option by yourself — and you’ll pay the maximum amount of interest. Sure, you’ll have a marginally nicer boat, but at what cost?
Life-Changing Debt Solutions
If you co-signed a loan or have a joint debt that you’re struggling to pay off, help is available — whether your partner is still in the picture or not. Schedule a Free Confidential Consultation with a Licensed Insolvency Trustee to find out how we can assist you today. During this initial, no obligation session, they’ll review your financial situation, discuss your challenges and goals and identify opportunities to get the financial fresh start you need and deserve.
You may qualify for a Life-Changing Debt Solution, like Bankruptcy or a Consumer Proposal, which could help you become debt free within as little as nine months. Or you might benefit from another option, such as debt consolidation or budgeting help, which they can provide referrals for. No matter what direction makes the most sense for you, a Licensed Insolvency Trustee will make sure you have all the information and options you need to make the right decision for your unique situation.
Don’t wait. Contact MNP today to get started on the path to erasing your debt for good.
