The Advantages and Disadvantages of Shared Financing and Obligations
In life, black and white situations are rare; most times, we navigate through the grey. This is particularly true when examining the subject of shared financing and liabilities. There isn’t a one-size-fits-all answer to whether it’s beneficial or detrimental. The key lies in understanding how both the benefits and drawbacks apply to your unique situation, and making an informed decision before finalizing any agreement.
Shared financial undertakings can often be advantageous. Pooling resources can enable you to reach objectives that might have been impossible individually. However, there are countless stories emphasizing the dangers of intertwining finances and relationships and their impact on credit scores, compatibility, and long-term financial stability.
There are various circumstances where considering shared financial responsibilities may be a viable option — from buying property with your partner to launching a venture with a friend. However, just because it’s an alternative doesn’t mean it’s always the best course.
Advantage / Disadvantage: Impact on Credit Scores
The effect on your credit score can swing either way, as your shared debt is evaluated based on your individual credit histories. If both parties are financially responsible and timely with payments, it could potentially boost your credit ratings. However, this requires that both parties:
- Pay bills punctually and in entirety.
- Consistently use less than 30 percent of the total available credit.
- Have no past records of Bankruptcies or Consumer Proposals.
- Not apply for new credit frequently.
This situation is ideal but in reality, one party may have a less impressive credit history or could potentially face financial hardship. In such a case, the effects can be damaging for the other party.
Envision a case where you’ve entered a joint mortgage with your partner. Initially, she had a stellar credit history, but a couple of years into the mortgage term, she loses her job. She doesn’t possess any emergency savings and now has difficulty paying her share of the mortgage, maxes her credit card, and misses several payments.
In the best-case scenario, her financial missteps will only impact your credit score, making it challenging for you to secure new debt in the future. However, it could also create problems when it’s time to renew your mortgage — affecting your ability to get a competitive interest rate or causing the lender to reconsider their relationship with you.
Disadvantage: Responsibility for Partner’s Unpaid Debts
It’s crucial to understand that both parties are equally accountable for repaying shared debts. It doesn’t matter who accumulated the debt, nor any agreements about how to split the payments. In the lender’s (and the courts’) eyes, anyone on a loan application — be it as a joint debtor or co-signer — can be subjected to collections action, wage garnishments, and court judgements to recover any outstanding payments.
Let’s examine another scenario to comprehend how this could become problematic:
- Assume you and your spouse have a joint credit card for shared expenses like groceries and other household needs. You agreed to only use the card for shared costs and divide the monthly payments equally. After several months, you discover your spouse has made personal purchases — maxing out the card — and hasn’t made his share of the payments. A confrontation leads to an argument and he decides to leave.
- It’s a terrible situation but what’s worse is that you’re still responsible for the debt. You could hire a lawyer to take him to court for his unpaid share. But in the meantime, the credit card company still expects someone to make the minimum monthly payments; and in the absence of your spouse, that person is you — unless you’re willing to risk severely damaging your financial future.
Disadvantage: Increased Tension in the Relationship
Co-mingling finances in a relationship is almost impossible to avoid, especially if you live with your significant other. Shared expenses are a given and it’s completely normal to be mutually accountable for common financial goals. However, introducing shared debt can quickly escalate healthy concern into unmanageable conflict.
Never enter a shared debt with anyone, be it a spouse, friend, or business partner, until you’ve had an open conversation about your approach to managing money and can determine compatibility. Trust needs to be established, expectations set, and boundaries created around how the shared debt will be used and repaid.
Some points you’ll want to discuss include:
- How do you budget and manage your personal finances?
- When do you usually pay your bills?
- How comfortable are you with outstanding debt?
- How comfortable are you discussing finances?
- How diligent are you about saving money — are you both prepared for a financial emergency?
- How do you handle and manage impulse spending?
- What are your rules for using and repaying shared debt?
What guidelines can you create for calmly and respectfully discussing shared debt — and prevent the conversation from turning into an unhealthy argument?
If you feel aligned after this discussion, introducing shared debt into the relationship might not lead to many issues. But remember, it won’t always be smooth sailing. You need to anticipate challenges and be prepared to confront them when they arise.
Advantage: Merging Purchasing Power May Lead to Lower Total Debt and Interest Rate
Your credit score and record aren’t the only factors a lender considers when deciding whether to lend money and at what interest rate. Two other factors include:
The size of your down payment — i.e., How much money you can give the lender upfront towards the principal value of the debt. The larger your down payment, the less debt you’ll need to reach the same purchase goal.
Your down payment and earning potential are important for lenders. For instance, if you want to buy a new boat worth $20,000, and you have a down payment of $10,000, the initial principal value of your loan would be $10,000. If you combine 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 the lender will be concerned about potential missed payments or loan default.
Several factors affect your potential interest rate, including the lender’s willingness to take on risk. The more risk, the higher the rate — and the less credit the lender will be willing to extend. By merging your resources into a shared debt, you can potentially save a significant amount of money both upfront (down payment) and over the lifetime of your loan (lower interest rates.)
Advantage: Greater Financial Resources to Repay Debt Faster
All other factors being equal, merging your resources with one or more people gives you a larger pool of money to draw from to make your debt payments. This generally means you can pay more towards the principal value of your debt each month above the minimum required payment — allowing you to repay the debt faster and reducing the total amount you’ll pay in interest over the lifetime of the debt.
Shared debts, therefore, have the potential to be less burdensome and less financially overwhelming when approached diligently and conscientiously. But, this only works if you avoid one MASSIVE pitfall that shared debtors often fall into — increasing the value of your debt to match your increased purchasing power.
Returning to the $20,000 boat example… 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, “I was already prepared to borrow $10,000. Our combined resources mean we could still borrow $10,000 and get 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?
Opportunities for Life-Changing Debt Solutions
If you co-signed a loan or have a shared debt that you’re struggling to pay off, help is available — whether your partner is still involved or not. Arrange a Free Confidential Consultation with a Licensed Insolvency Trustee to explore how they can assist. During this initial, no-obligation session, they’ll review your financial situation, discuss your challenges and goals, and identify opportunities to get the fresh financial 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, for which they can provide referrals. No matter what direction makes the most sense for you, a Licensed Insolvency Trustee will ensure you have all the information and options you need to make the best decision for your unique situation.
Don’t wait. Reach out today to begin your journey to erasing your debt for good.