When I was a 20-year old student, my mom co-signed a $7,000 line of credit for me because I couldn’t get approved for one on my own. My original intention was to use $2,000 and buy a used car, because I needed (looking back, this was true – I did actually need one) a car to shuttle me back and forth between school and my three part-time jobs. But by my 21st birthday, I had borrowed the entire $7,000 and lived with a maxed out line of credit for the next three years of my life. Yeah. :|
Aside from the $1,600 I ended up spending on a used car, I couldn’t figure out what I spent the rest of my money on. So when I finally graduated college, not only did I end up owing $14,000 in student loans and $2,100 on a maxed out credit card, but I had put myself an additional $7,000 behind by maxing out my line of credit as well. And for what? I didn’t have a single thing to show for it, except for a crappy car that was almost as old as I was.
I finally hit rock bottom when I couldn’t afford to put gas in my car, and I didn’t have enough money to take the bus to get to work. I had a major problem, and it was that moment that made me want to change my life forever. I created a plan, and gave myself 12 months to become completely debt-free.
Once I got around to tackling my line of credit debt (I got to it last, because it had the lowest interest rate), I realized I had made four crucial mistakes which led to my downfall:
1. I used my line of credit like a chequing account
For years, I abused the line of credit because I didn’t think I could pay it off without sacrificing my lifestyle – and I hated the feeling of being broke. So instead of paying the balance down, I would deposit my entire pay cheque into the account to satisfy my monthly payment obligations. Then, I would spend out of my line of credit, just like a chequing account. And when my pay cheque wasn’t enough to cover my monthly expenses, I freely spent more than what I made because I had the credit there to supplement my income.
The Fix: I stopped the cycle by creating a debt-repayment plan, living on a budget, and increasing my income. My goal was to be completely debt-free in 12 months, so I broke down my $7,000 debt into bi-weekly payments of around $270.
2. The limit on my line of credit was too high
When I first inquired about a line of credit from TD Canada Trust, I only asked for a $2,000 loan. I didn’t get approved for it on my own, so when my mom agreed to co-sign my loan, I was approved for up to $7,000. I didn’t need that much, but the financial advisor at the bank and my mom both recommended I take the entire $7,000 loan “just in case of an emergency.” Little did I know that my emergencies would end up being lattes and clothing!
The Fix: Every time I paid off $500 on my line of credit, I would call the bank to have my limit lowered by the same amount. It meant that I remained maxed out as I paid off my debt, but it also meant I wouldn’t be tempted to fall back into old habits and use credit to supplement my income.
3. Asking my mom to co-sign the line of credit
Getting declined for the loan on my own should have been a sign that I was not ready to take on the financial responsibility that came with the line of credit. And putting my mom’s financial reputation on the line like that – while it was one of the nicest things she has ever done for me – was not fair of me to ask her to do.
The Fix: Once I paid off my line of credit, I called the bank and asked to put the loan under my own name.
4. I kept consolidating my credit card debt
Whenever I did end up being successful in paying down my line of credit by a few hundred dollars, I would use the credit room I had created to help pay off my constantly maxed out credit card. Then I would spend until my credit card was maxed out again. This vicious cycle meant that every time I tried to get ahead, I ended up even farther behind.
The Fix: Because the interest rate on my line of credit was so low, I consolidated my credit card debt one last time, and created an aggressive debt-repayment plan. By being able to pay down both my line of credit and remaining credit card balance at the same time, I eliminated the need for another consolidation.
Even though it can be easy to spend more than you can afford to pay back with a line of credit, it is a great tool to have because it can provide you with a low-interest way to borrow money when you need it. But because it is also so accessible, so many people fall into the trap of abusing their line of credit. It took me less than a year to max out my line of credit, and over 4 years living with the weight of that debt hanging over my head.
If you’ve ever been in the position where a friend or family member has asked to borrow money, you know how difficult it can be to say no. You want to help them out because you love them … but money has a funny way of putting a strain (or even potentially destroying) strong relationships. Gifting money is one way of avoiding a potentially complicated situation, but if you don’t have any money to give, what do you do?
I’ve been in this situation before, and it’s really stressful. When I was in my early 20’s, I had a maxed out credit card and no savings, but someone I cared about needed my help. He was sick and couldn’t work when he was in and out of the hospital. He couldn’t pay for his bills, rent, or his medicine. So over the span of just under a year, I loaned him thousands of dollars out of my line of credit, with his promise that he would give every penny back to me. Ha!
There are plenty of other ways you can help somebody out financially, without handing over money. But when it’s somebody you care about, there are times where you might find yourself saying yes (like I did). Whether it’s a loan of $20 or $20,000, your ideal situation would probably involve recuperating all of the money you lent. Unfortunately, it doesn’t always work that way.
However, if you’ve weighed the pros and cons, and you still feel like loaning money is what you want to do, here are a few suggestions to help you protect yourself as best you can:
Loan or gift?
The most logical thing to do is not to loan the money – but to gift it – instead. For smaller loans, sometimes gifting the money is the easiest thing to do. You don’t have to worry about monitoring repayment schedules, what to do about late payments, or any hard feelings if the borrower can’t come through on paying you back.
If you decide that you will loan the money, you must still assume that you’re not going to be paid back. Many personal loans are never repaid, and you will be disappointed and resentful if you keep expecting money that will never be returned.
Don’t loan money you can’t afford to lose
Life can be unpredictable, especially for those who aren’t financially able to stand on their own two feet. Even the most responsible person can end up defaulting on a loan, so don’t lend any money you can’t afford to lose. This includes money from your Emergency Fund. You never know when you’ll need the money, and if it’s not there when you need it the most, not only will you feel resentment towards the borrower, but you might end up needing to borrow money yourself!
It’s also important to note that if you have any credit card or high interest consumer debt, or if you have to use credit to loan the money, you cannot afford to help out.
Get it in writing
Don’t make a verbal agreement. Make sure you put down in writing all of the fine print regarding the loan. Then have both parties sign and date it. Include the amount of the loan, interest rate (if applicable), repayment schedule, consequences for late payments, and potential collateral should the borrower end up defaulting on the loan. Try to be as specific as possible; you never know when it will come in handy down the road if something needs to be clarified.
Negotiating the nitty gritty payment details might cause some heated arguments and disagreements – after all, money is a sensitive topic. Consider bringing in a neutral third party to act as a mediator.
It can cause a lot of resentment and anger if you loan somebody money for a specific reason (like paying for tuition or the heating bill), only to see them spend it on something else instead. So if somebody has asked you for a loan for late bills, rent, or anything with a specific recipient, and you’re concerned the borrower might end up spending the money on something else, tell them you will only loan them the money if you can pay directly to where the money is owed.
Think twice about co-signing a loan
If you’ve refused a request to borrow money, and they’ve asked you to co-sign a loan for them instead, think really carefully about your decision. It might seem like a good idea, but once you’ve co-signed for a loan, you’re legally responsible for that debt. If something goes wrong and the borrower can’t – or decides not to – make payments, you’ll be stuck with the entire debt.
If you haven’t already been in the situation where you’ve been asked for money, chances are, you eventually will be. Deciding how you will handle the situation before it arises will ensure that you are less likely to be pressured into loaning money that you can’t afford, or don’t want to give. My relationship quickly deteriorated with the person I loaned money to. Once he was back on his feet, he started making small payments. However, that only lasted a few months before the payments stopped – not because he couldn’t afford them, but because he didn’t feel like making them anymore. I eventually sued him (and won) in small claims court, but to this date, I’ve recovered less than half of what he owed me. It’s something I hope to never go through again, and that’s one learning experience I’ll never forget.
I still lend money occasionally, but in much smaller amounts (usually never over $100), and I never expect to get my money back (although it’s great when I do). This leaves me with no room for resentment or anger, and our friendship stays in tact.
So if you do decide to loan money to a loved one, remember that no matter how agreeable the borrower is to your rules and terms of payments, or how enthusiastic they are about paying you back, you might not end up with the happy ending you want. Hope for the best – but make sure to plan for the worst.
Have you ever loaned money to a loved one?
According to a recent study done by a group of sociologists, young adults (aged 18-34) can actually benefit and improve their self-esteem by carrying debt. Debt has the ability to give them a feeling of “mastery” – or the idea of being in control of something. And the more debt you have, the bigger the boost you seem to get. That’s the good (?) news. The bad news is, this false sense of confidence only lasts until you’re 28 – when, as you can imagine, it starts to have the opposite effect. The study found that debt boosts self-esteem because it allows you to live large. Being able to rent the apartment all your friends are jealous of, buy nice clothing, go to those fancy restaurants, or attend that expensive University – it is all attainable to you, as long as you’re willing to sign on the dotted line and live beyond your means. Sound familiar? That’s how I lived for quite a few years.
The study goes onto talk about how young adults might “experience debt as an investment in the future,” regardless if it’s student or consumer debt. Once young adults reach the age of 28, the good feeling associated with carrying debt tends to wear off. They might start to realize that they overestimated how much money they thought they were going to earn at their jobs, and/or that paying off their debts is not as easy as they had anticipated.
But what I found most interesting about the study is how debt affects young adults is dependent on what other financial resources they have available to them. If they come from a wealthy family, they might receive no self-esteem boost whatsoever from carrying debt. However, those that come from a family in the bottom 25% of household income got the largest psychological boost from having debt. Spending beyond their means might make them feel better about themselves – but the drawback is that in doing so, they are making it much more difficult on themselves to overcome their debt (and potentially their low-income status) in the future.
I started to feel guilty about my debt when I was 24. In the 5 years previous, I had racked up $21,000 in debt. So if I hadn’t decided to do something about it, my credit card and student loan debt could have easily doubled by the time I turned 28. It’s kind of a scary thought.
Did your self-esteem improve by carrying debt and living beyond your means? At what age did you start to feel guilty about your debt?