Divorce can be emotionally and financially traumatic, potentially generating debt as you and your spouse split income and assets. Taking out a loan to tackle some of that debt might seem like adding gasoline to the fire, especially if your income will be dramatically slashed once the divorce is final.
But depending on your circumstances, taking out a divorce loan could be a good option for the next stage of your financial life. Here’s a look at how a divorce loan can help or hurt your post-divorce finances.
[Read: Best Personal Loans.]
What Is a Divorce Loan?
A divorce loan is a personal loan used for divorce-related expenses. Personal loans are unsecured loans that allow you to borrow a specific amount of money and pay it back, usually in monthly installments.
Interest rates for personal loans are usually lower than rates for credit cards but higher than rates for secured loans, such as home or auto loan. A secured loan is a loan backed by assets you own, which can be used to compensate the lender if you don’t repay the loan.
Do You Need a Divorce Loan?
Whether you need a divorce loan will depend on the cost of your divorce and your financial resources.
Divorce expenses vary. If the divorce is amicable and legal costs are low, you might not need a loan. But if you go to trial, prepare for sticker shock from depositions, experts, preliminary hearings, the trial itself, as well as possible appeals.
An uncontested divorce could cost a few thousand dollars, a contested one could run at least $10,000, and a divorce that goes to trial might top $20,000, according to a Martindale-Nolo Research divorce survey.
And divorce complicates finances. Both spouses need to review budgets for both day-to-day and unplanned expenses if they are limited in what they can withdraw from joint accounts.
The court might assist by mandating payments from one spouse to the other or by allowing both spouses to tap joint accounts. Meanwhile, a divorce loan can bridge the gap between when you need money and when you can actually access it.
Plus, if your settlement requires you to divide assets that aren’t easily liquidated, such as your home, you might need funds to facilitate that process. For example, you might need to come up with the money to buy out your spouse’s share of the property, says Leslie Tayne, debt attorney and founder of Tayne Law Group.
“If you and your spouse have joint debt, a divorce loan might help in consolidating that debt and paying it off so that you can start with a clean slate post-divorce,” Tayne says. “Also, if the divorce means you need new living arrangements or you need to buy items for a new household, a loan may be necessary to cover those costs.”
[Read: Best Home Equity Loans.]
Can You Get a Divorce Loan?
Your ability to get a loan could be made difficult by divorce proceedings, especially if you’re not sure about your ability to pay back the loan once the divorce is finalized. If you can, wait until you have a clear picture of your income, assets and expenses.
Financial counseling can help you triage your debts and expenses. If you have a lot of debt, a divorce-related loan might not be a good idea.
“You need to consider your ability to repay as well, if you’re going to take on a new loan,” says Rod Griffin, senior director of public education and advocacy for credit reporting bureau Experian. “Divorce can make it difficult to know. You’re trying to set up a new, independent life and figure out what housing, transportation and utility costs are going to be. Then you have to pay off this divorce cost as well, which adds to your financial burden.”
Is a Divorce Loan a Good Idea?
Your credit history and debt can help you determine whether a divorce loan is a good idea.
A divorce loan can help you consolidate and pay off debt and build your credit rating if you lose valuable credit history when your name is removed from joint accounts. If you didn’t build your own credit history during your marriage, you will likely struggle to qualify for car or home loans at favorable interest rates after your divorce.
Getting a personal loan and making all of your payments on time is an ideal way to build credit. “It’s beneficial in that sense,” Griffin says. “It can help you establish and build credit history that will work for you in time.”
Still, divorce loans aren’t for everyone. A loan is a common form of debt, and a loan with a high interest rate can complicate what may already be a tenuous financial situation. Making a monthly personal loan payment may be unrealistic if you are also trying to find a new place to live, manage on one income and pay divorce costs.
“Taking on debt, if possible, should be the last resort,” Griffin says. “You likely already have joint debts and are responsible for repayment of some of those as well. Taking on additional debt on potentially reduced income and reduced assets can make it even more difficult.”
Whatever you do, avoid payday loans or other predatory loans, which are short-term loans with sky-high interest rates. The interest charges can add up quickly if you can’t pay off your loan right away.
[Read: Best 0% APR Credit Cards.]
How Do You Finance a Divorce?
There are a few other ways to deal with divorce-related debt.
— Negotiate legal payments. Ask your lawyer if you can pay off your bill over a period of months or even years. Plus, “in some cases, especially for more straightforward divorces, a lawyer may agree to a flat fee for the entire process. This can help you to know upfront what the legal fees will be,” says Tayne.
— Tap your home equity. If you came out of the divorce with sole ownership of your home and qualify for a home equity line of credit or loan, you could get a better rate than on a personal loan. However, be aware that you could lose your house to foreclosure if you fall behind on payments.
— Consider friends or family members. You might choose this option if you’re confident that you can pay back the money as agreed. Otherwise, you can damage — or even end — another relationship.
— Borrow from retirement funds. This is not an ideal option, but it might enable you to get money right away. You could make a withdrawal from an individual retirement account or a 401(k), or take a 401(k) loan. “However, keep in mind that you’ll lose out on compounding returns on the money you withdraw, which could put you behind on your retirement goals. Additionally, if you fail to pay back the loan according to the terms, the entire amount could become due, and you’d owe additional taxes and penalties,” says Tayne.
— Use a credit card. Tayne says, “While not ideal due to high interest rates, using a credit card to pay for some divorce expenses is an option. Some people [go this route] if they expect to be able to pay off the balance quickly after the divorce is finalized.”
— Tap any qualifying aid. “If you have a low income, you may qualify for assistance from legal aid societies, which provide free or low-cost legal services,” says Tayne.
Your Post-Divorce Finances
After the divorce, a new financial reality will follow for each spouse.
Taking stock of income, assets and expenses, as well as setting up a budget, will be crucial for securing a strong financial future. Tayne says, “Creating a new budget after a divorce is an important step in establishing your financial independence and security. You’ll need to calculate your new monthly income, including alimony or child support, if applicable.”
Then, you must add up your expenses, including fixed bills like your mortgage, and variable costs, like groceries. “Once you have your income and expenses accounted for, you can establish short-term and long-term financial goals, such as building an emergency fund, saving for retirement, or paying off divorce debt,” says Tayne. “Make sure you track your spending and review your budget regularly to make adjustments as needed.”
While getting a divorce can wreak havoc on your finances, you can rebuild over time. “You’ll need to do some financial housekeeping, such as removing your ex-spouse’s name from any joint bank accounts, credit cards or other financial accounts, and updating the beneficiaries on your retirement accounts, life insurance policies and will,” Tayne says.
Then, you can shift your focus to paying off debt, amassing a tidy nest egg and boosting your credit score. You may have to limit your discretionary spending or downsize your home during this transitionary period. However, no season lasts forever, and you can come back stronger than ever– financially and otherwise.
More from U.S. News
Can You Get a Loan After Bankruptcy?
Should You Get a Home Equity Loan Now?
What Is a Good APR on a Personal Loan?
Should You Get a Divorce Loan? originally appeared on usnews.com
Update 11/22/23: This story was published at an earlier date and has been updated with new information.
