Managing your personal finances wisely is one of the hallmarks of a responsible and mature person. Unfortunately, not everyone is able to or willing to handle their own financial affairs. Sometimes money problems occur as a result of circumstances; other times poor decisions play a role. Either way, it can be heart-breaking to watch as your friends or family members struggle to free themselves from the shackles of debt or other financial woes.
If you’ve found yourself with some extra cash, you may be thinking that you can alleviate their problems by simply paying off a loved one’s debt.
Is this a good idea? After all, you may be thinking: what could go wrong?
Well, we’ve all heard the saying, “don’t mix business and pleasure,” but of course, that is easier said than done.
Just as you’ve made at least some smart decisions about your own finances, you should use the same discretion to determine whether paying off someone else’s debt—even for your children—would make financial sense.
Before making your final decision, let’s weigh some of the pros and cons associated with paying off someone else’s debt.
The Pros of Paying Off Someone Else’s Debt
Helping Someone Stay Afloat or Recover From a Setback
Debt can be emotionally crippling for those around us. Sometimes people we care about can fall into a never-ending series of problems. There could be career difficulties, health issues, relationship drama – or other challenges. And when misfortune strikes, bad things seem to come one after the other. The result is that a relative or close friend may slip into a downward economic spiral, complete with overdraft fees, rising interest rates, debt, and even collection accounts, repossession or home foreclosure.
Obviously, it’s hurtful to see a family member or friend getting mired in an ever-deepening hole. Hopelessness and despair can plague plague the person and your natural inclination may be to help out financially. After all, life is more than just money, right?
While someone else’s financial problems aren’t necessarily your responsibility, providing financial help can help another party stay afloat or recover from a temporary setback. In fact, you might even think that refusing to help someone – say, your adult children – may cause them to experience feelings of abandonment. Similarly, a spouse or a significant other may resent you if you aren’t willing to help them out economically. This is especially true if they’ve helped you in ways that have benefited you financially.
So in some ways, paying off someone else’s debt at least gives that person some breathing room and a fighting chance at economic recovery.
Providing a Clean Slate and a Fresh Start
Besides, we all make mistakes when it comes to money matters. Admittedly, it’s nice to have someone step in and make financial problems go away. It may only be a small debt that is tangling up a friend’s finances.
Providing a fresh start for your children is a common motive for parents who realize that becoming financially secure isn’t always easy — especially when certain predatory lenders, like payday loan companies, charge exorbitant rates of repayment for loans. Under such circumstances, if your adult child is caught up in the payday loan cycle, he or she may not be able to pay other bills, which can cause their credit to nosedive. So stepping in to alleviate their financial woes can reorient their finances in a positive direction.
Protecting Your Own Credit Score
If you’ve cosigned for a loan or a credit card for those that couldn’t qualify without your help, remember that paying off the debt is in your best interests. It may have been a loving gesture to do so, but cosigning is risky—hence lenders hedge their bets by requiring a person with a solid credit history to serve as a cosigner. Even though you’re not listed as the primary account holder, all activity associated with these accounts will show up on your credit, including outstanding balances and late payments. Ultimately, you’re responsible for these debts if the person you cosigned for doesn’t pay.
Qualifying for Larger Financial Purchases
If you’re looking to qualify for a large business loan or a mortgage, it should be noted that many lenders will look at your finances as well as your spouse’s. Lenders will typically weigh the entire income and evaluate the credit scores of both spouses to determine the loan amount and repayment terms. If there’s lingering debt, it will play a role in whether your loan is approved or not.
You must also ask whether you would you be able to afford your dream home on just your income alone. A combined income goes a long way toward affording a house that you may have to compromise for versus the one that you and your spouse fall in love with as a “dream” home. Additionally, having both names on the title can help keep the peace down the road, especially when weighing large financial decisions in the future.
The Cons of Paying Off Someone Else’s Debt
Messing Up Your Own Finances
Misery loves company, and this seems to be especially true with money matters.
If you undertake/cosign a new loan or empty your savings to cover another person’s financial mistakes, be forewarned that their financial indiscretions could bleed over into your life.
Your credit may take a hit, which may make obtaining future loans or credit much more difficult.
So consider this: if you use your emergency fund to put your friends and family back on track, could you count on others to do the same for you?
If the answer is no, you may want to reconsider paying off someone else’s debt. Similarly, if your own finances are shaky and your disposable income is small, you may have your own troubles meeting your recurring bills. Late payments and damaged credit can wreak havoc on your previously-stable financial situation.
Bear in mind that if you decide to withdraw funds from a retirement savings account (i.e. 401k, IRA, etc.) to pay someone else’s debts, you will be liable for early-withdrawal penalties and hefty taxes — not to mention foregoing the growth-potential of those funds, stunting your hard-earned retirement.
Enabling Financial Problems
Paying off another party’s debts may make you feel being, and it could bring some emotional relief to the other person too. But have you also considered that you may be doing more harm than good?
If one of your friends or family is constantly beleaguered with debt or chronic money problems, that likely signals a lack of financial planning, indiscriminate spending or overall poor money management skills. Ask yourself the question honestly: Would this money change their behavior? If your intuition tells you that you’ll be setting a precedent for bailing them out, consider not paying off their bills.
While you may be tempted to offer a loan with the understanding that the borrower pays you back, would they realistically be able to do so in a fair amount of time? If not, you may reconsider offering to help, or at least for the total sum of their debts.
It’s always helpful to consider the worst-case scenario when it comes to financial matters. Would your relationship be worse off if the borrower never paid you back? Some people tend to avoid those that they owe an outstanding debt to, whereas others may resent having to resort a helping hand. Worse, you may find yourself resenting the borrower for getting you into their financial mess in the first place.
For married couples with joint finances, paying off someone else’s debt can cause major disruptions or tension in your relationship. Your spouse may have different opinions on how to best handle the situation. And please don’t even think about “loaning” or giving money on the sly, without your partner’s knowledge! That’s a classic case of financial infidelity. And going behind your spouse’s back may cause lingering resentment and trust issues.
After all, there is a reason that money is typically cited as the leading cause of stress and divorce. This certainly plays a factor with children and stepchildren, whom may exacerbate any previously-benign feelings.
Those that have a boy/girlfriend in their lives may feel stable in their relationship to provide for those that they love—including their extended family-to-be—but there’s always a chance that a relationship could get derailed in the future. Paying off a significant chunk of your girlfriend/boyfriend’s bills will make the breakup significantly worse, especially if things get really nasty and you find yourself dragging one-another to small claims court to try to recoup your losses.
Beyond the Pros and Cons
The bottom line of paying off someone’s debt is to realize how the risk factors involved. No one wants to become a bank for another person’s spending, but they also don’t want to strain any relationship by choosing to intervene or not. The outstanding bills and debts are often indicative of deeper financial problems than just simply forgetting about a bill. Were those debts incurred from a brief period of financial indiscretion, a monetary setback (like medical bills or accidents), or just poor planning?
As a way of insulating yourself from other people’s problems, if you decide to provide a loan or payoff someone’s debts, there are a couple of things you can do to help:
- Establish Payments on a Timeframe: Before lending money, decide with the borrower on a realistic period of time for getting them out of debt. Whether the debt is paid off weekly, bi-weekly, or monthly, be firm with these details and agree on the amount per period and whether you should charge interest.
- Get It in Writing: The smartest way to make sure that you can safeguard yourself is to have a legally-binding document stating the amount owed and the timeframe. While no one wants to drag their friends and family through court, the simple threat of resorting to those measures may give an incentive to those who owe money. This also help clear up any misunderstanding in the future for those who view your generosity as a gift and not as a loan.
- Go over Their Expenses and Income: Getting to the heart of the matter, income and expenses are what caused the person to fall into debt. If the person you’re giving money to doesn’t allow you to see their finances, you may want to reconsider giving them money. After all, they may be hiding detrimental facts about their finances that will most likely put them back into debt in the future. It can be demeaning to have another person look into their finances, especially if the recipient is sensitive about their income. However, does this outweigh the reality of being handicapped by debt? Even a cursory look at a bank statement can help you pinpoint just where the money is going that led to their current situation. Budgeting may turn off some people, but therein may lay the problem that caused their hardship.
- Suggest Alternatives: Throwing money at a problem may not always be the best course of action. Remember that there are a number of alternatives to get their finances in order, including debt consolidation or even seeking out higher-paying employment. For those with significant money owed in taxes, there are options like an Offer in Compromise. Even recommending licensed credit counselors (many of which offer to work pro bono) can offer unforeseen ways out of a financial hole.
Couples that are financially tethered need to be on the same page financially and have their financial philosophies align when it comes to saving and spending. A difference in opinions can tear up otherwise stable relationships. For those that want to bail their children out from financial hardship, paying off a child’s debt is a personal decision that must be carefully considered. In the end, only you can decide whether it is a good idea to pay off someone else’s financial obligation. Just choose wisely – and with eyes wide open!