Weighing risks, rewards of a family loan
By Erica Sandberg
May 17, 2016
I told my uncle that I was filing for bankruptcy, and he said I shouldn’t do that. He said he would lend me what I needed to pay off my debts. He said I could pay him back once I am working. My job doesn’t start until June. What should I do? — Van
Without knowing the intricacies of your family dynamics or anything about your upcoming job (How much will you earn? How secure is the position?), it would be difficult to know if taking your uncle up on his offer would be a good idea. However, I can try to help you make that decision.
A Chapter 7 bankruptcy can work well for people who are unable to cover certain bills, not just now but also in the future. If you qualify, you would be able to wipe out all dischargeable debt. That usually includes unsecured balances that you have on credit card accounts, medical bills and collection agency debt. What is not dischargeable are student loans — just in case that is what is bogging you down.
There also are disadvantages to bankruptcy. A bankruptcy will be on your credit report for 10 years, and especially in the first two years, your credit rating will be deeply impacted. If you have any assets that can be claimed and sent to pay the creditors, you’ll have to forfeit those.
But you have an option, in the form of a personal loan, but going this route also has benefits and drawbacks. For example: While your uncle won’t be reporting your regular payments to him to the credit bureaus, his loan can help you keep on track with your creditors, preserving your credit rating (or even perhaps improving it). On the other hand, if you fail to pay your uncle on time, your credit rating won’t take a hit because of delinquencies.
With a personal loan, what’s at risk is your relationship with your uncle. You have to be comfortable being financially obligated to him. That can make for some awkward moments, because owing a friend or family member puts you on unequal footing. If your uncle needs his lawn mowed or house painted, he may turn to you and say, “Oh, Van, after all I’ve done for you, how about doing this for me?” And if you miss payments? Be prepared for the fallout.
Personal loans are inherently complicated and because of this, I am not a big fan of them. However, if you would rather keep your credit clean with your uncle’s help, you can minimize problems by drawing up an agreement that you can — and will — honor. This contract should include the following:
- Your names.
- Amount of the loan.
- Date of the loan.
- Payment amount.
- Date you will begin making payments. I understand that your uncle left the actual start date open, but that’s too nebulous. Be clear.
- Monthly date on which you will be sending payments. (For example, you might agree to make your payments always on fifth of the month or the first Monday of the month.)
- Method of payment (PayPal, personal check or cash. Be specific.)
- Maybe you have something of value that your uncle can keep while you’re repaying him, or that you’ll promise to give to him if you renege on your loan agreement. This could make you feel more at ease, too.
Both of you need to sign the document, and have a third-party witness and sign the loan agreement, too. Make a copy for each of you. Then make your payments on time and in full until the loan is repaid.
If you decide you don’t want to accept your uncle’s offer of a loan, that is your right. Thank your uncle for his generous offer, and either move forward with the bankruptcy or notify each of your creditors that there will be a delay in payments.
Ask your creditors if they would be willing to hold off collection action or legal proceedings until you begin bringing in a paycheck again. No lender or collection agency wants a person who owes them money to discharge the balance due in a bankruptcy, so some creditors might be willing to work with you to avoid that scenario.
Got a question for Erica? Send her an email.