Should You Take Out a Loan to Fund Your Divorce?
For couples, self-isolation is like a test run for retirement. It's a whole lot of togetherness for partners who may not be accustomed to it -- and a moment to reflect, do I really want to spend the rest of my life with this person?
Add that to the stress and financial strain caused by the coronavirus, and experts expect to see some marriages become another casualty of the pandemic. Anecdotal evidence has shown a spike in divorces in China as couples emerge from quarantine. "It can be a game changer when you are forced to spend significantly more time with your partner, for better or worse, and this may push some couples toward separation once the pandemic is over,” says divorce lawyer and mediator Rebecca Provder of Moses & Singer.
The crisis adds a layer of urgency: "There's also a feeling of time being short and not wanting to continue an unsupportive, unhappy marriage when everyone’s situation feels dire,” says Valerie Tocci, a partner with the matrimonial law firm of Stutman Stutman & Lichtenstein.
But divorce is expensive. According to Nolo.com's research, the average cost of a divorce in the U.S. is $12,900, and it can go much higher when the case goes to trial. With a staggering 16.8 million jobs lost in just the last three weeks, many Americans are facing an abrupt loss of income that makes footing this bill a daunting prospect.
So, what happens when you want out but lack the resources? Some are turning to divorce funding, an under-the-radar option where you borrow from a private lender for divorce-related costs like attorney’s fees, forensic accountants, appraisers, and sometimes, living expenses during the interim of the divorce.
Divorce funding is a loan against the ultimate divorce settlement. Think of it as an advance. This type of loan is unique in that eligibility is based on the expected divorce settlement proceeds, not current assets, income or credit score. There may be a promissory note, or a binding obligation to repay at the end of the divorce, once the marital assets are divided.
The lender determines the loan amount after taking an inventory or an assessment of the marital estate and the likely percentage of the estate that the borrower will recover, says matrimonial attorney Ken Jewell, of Jewell Law.
Nicole Noonan, CEO of New Chapter Capital, one of the largest divorce funders in the nation, says of the process, “We do not approve every client. We also will not permit funding where the asset pool is insufficient or where there is a pre-or post-nuptial agreement that adversely limits the fair distribution of assets.”
Each lender has its own standard for what amount is worth their while. Noonan says while there's no strict minimum for an asset pool, funding requests of less than $25,000 generally wouldn't make economic sense for the applicant or the lender.
Of course, would-be divorcees sometimes have no choice but to borrow money in order to pay for divorce representation and protect themselves. “Divorce involves the most intimate and important aspects of our lives -- our families and personal finances -- and the court process can be complex and confusing," says divorce attorney Emily Rubenstein. "Every case is different, but if this is the only way to access legal assistance, it makes sense,” she adds.
Here's what to know if you're considering applying for a divorce loan:
The pros
--You have a line of defense from the start. People may begin divorces on their own to save money, but they sometimes find that it's too complex and they ultimately need representation. “At this stage, it's generally more expensive to bring an attorney up to speed and triage the case than it would have been to have good representation from the beginning,” Rubenstien says.
--It can serve as a safety net. “The funding gives you a war chest that you can use to be more aggressive in a divorce litigation out of the starting gate. It can help you maintain your lifestyle in a divorce where your spouse is hiding assets or refusing to pay support,” Tocci says.
--It allows you to hire the best defense possible. A loan also gives you a chance to hire an attorney you might not have been able to afford otherwise, Jewell says. In such high-stakes proceedings, you want the best talent representing you.
The cons
--It could cost you more down the line. Divorce funding typically comes with high interest rates. This is because there’s slightly more risk involved for the lender. Jack Choros, chief marketing officer of SophisticatedInvestor.com explains, “What if you’re the one who bears most of the responsibility for taking care of kids and you’re not working during the proceedings?”
If an unsecured line of credit is 5%, divorce funding would likely be at least 6% or 7 %, maybe as high as 10%, Choros says.
Also, you might not pocket that much in the divorce settlement. You won't know until the divorce is finalized how much you'll receive in the settlement, and it's possible that your borrowing costs will eat into your take. “A large chunk of the divorce settlement may need to be used to pay off the amounts borrowed to fund the divorce,” cautions Provder.
--The lender may have the the last word. “Any settlement must be approved by the lender," says Alton Abramowitz, partner and chair of the matrimonial department at the law firm of Schwartz Sladkus Reich Greenberg. "All of this impacts the strategies that can be employed because the borrower spouse cannot freely make decisions about the conduct of their case.”
However, if the couple can't reach a settlement on their own and proceed to court, the lender's influence is curtailed. “A lender cannot tell a judge what to decide," Abramowitz says. "Settlements are voluntary agreements between the parties. Court decisions are determinations made by a judge because the spouses are unable or unwilling to reach an agreement."
--It can affect your retirement date. Borrowing can be particularly tricky for those approaching retirement. “Repaying your loan over time could increase your cost of living and delay your ability to retire,” says attorney Rajeh Saadeh of the Law Office of Rajeh Saadeh.
Saadeh says to ask yourself what you are trying to preserve or obtain in your divorce. “If you are trying to obtain $100,000 in your divorce, you don’t want to spend or borrow $100,000 to do so. You want to borrow or spend less than that. Smart borrowing will require an accurate diagnosis of your case at the outset, and able counsel can help make that diagnosis.
When your loan comes due, it could be painful. Loan terms vary by lender and circumstance but are typically in the 18 to 24-month range. Older borrowers in particular don’t have the luxury of time to help recoup the loss. “It’s similar to the difference in impact of a 30% stock market decline when one is 35 and when one is 70 and just starting retirement,” says Robert Friedman, a certified divorce financial analyst.
Truth is, divorcing spouse are already likely to be cutting their liquid assets and retirement funds by around half when they finalize their divorce, so piling on more debt can have a detrimental financial impact, says John Whitbeck, a divorce attorney with Dunlap Bennett & Ludwig.
The alternatives
--Enlist family and friends or low-performing assets. Consider asking family and friends for a loan. Do you and your spouse have a low-performing liquid asset that you could split to fund fees, like a CD or bonds?
--Explore mediation. Mediation is cheaper and can be quicker than a long, drawn-out divorce proceeding.
--Tap into your home equity. Another strategy worth considering is a home equity line of credit. “This particularly can make a lot of sense if all parties agree that ultimately the home will be sold or one party will be buying the other out, and would provide short-term and interest-only lending facility that both parties could potentially draw from to fund divorce costs,” says Chris Kampitsis, a registered representative with the SKG Team at Barnum Financial Group.
--Consider separation. Debt.com and Moneywise.com recently partnered to survey divorced people. They found that 40% ended up with a debt of $5,000 or more, post-split. Howard Dvorkin, chairman of Debt.com says separation might be a better option for those who know they cannot afford a divorce but still want to split. He says, “Surprisingly, 88% of survey respondents didn’t consider separation as an option to to save money." But if you don't see yourself getting remarried--a big if, to be sure--then separation may be a way to save many thousands of dollars.
--Ask about a payment plan. Attorneys will often work out payment plans with clients. These aren't loans, but simply a way to spread payments out over more time.
--Tap your retirement plan. This should be a last resort. Not only are you hit with a 10% penalty if you withdraw money from your accounts and you're under age 59 ½, but also you're robbing yourself of funds for the future. And if it's a traditional account, you'll have to pay any income tax on the funds you withdraw, so you'll have to take out more than you need to pay for the divorce.
--Use your credit cards. While credit cards do have higher interest rates than loans, you can pay them off whenever you want without incurring a prepayment penalty. Additionally, it's generally quicker and easier than waiting to be approved for a loan.
The bottom line? Taking out a high-interest rate private loan to pay for a divorce shouldn't be your first choice. Explore the alternatives first.
Correction: A previous version of this story misstated Chris Kampitsis' firm. It is the SKG Team at Barnum Financial Group, not MML Investor Services. Also, Nicole Noonan's firm is New Chapter Capital, not Next Chapter Capital as previously stated.
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