Susan Rivers, just two years out of college, had her ideal first job. Seeking a long-term hospitality career, she landed an administrative position at a beach resort. What could be better?
Truthfully, she already was drowning in debt.
Due to careless spending and pressures from student loans, her credit card was maxed out. Expenses were draining her salary. Where to turn? Where else?
“I was embarrassed,’’ Rivers said. “Of course, they wanted to help me, but I was still embarrassed. I had to go there because things would’ve just gotten worse.’’
Borrowing money from family and friends always has been a viable option. The benefits are obvious. There’s no application process. You will get a favorable interest rate (or none at all). And if there’s a late payment, it won’t be reported to the credit bureaus.
But there’s a downside.
“I would advise against borrowing from a friend or family member unless you have exhausted all feasible options and/or they are willing to give you an interest-free loan,’’ said Mark Beyer, a financial advisor with Edward Jones.
Relationships can be fractured if the situation isn’t handled professionally, just like business with a real bank. Anthony Cherin, professor emeritus of finance at San Diego State University, said parents also should avoid the common practice of co-signing a car loan or a credit card for their children.
Cherin said to avoid risk, it’s better to assume the role of lender than to co-sign and statistics back him up. According to a CreditCards.com survey of more than 2,000 co-signers on loans, nearly 40% of people end up covering some or all of the borrower’s payments, while 28% did damage to their own credit scores.
According to the Federal Reserve Board Survey of Consumer Finances, loans from family and friends add up to $89-million per year in the United States.
“There can be emotions when it comes to families and money,’’ Rivers said.
That’s why it’s necessary to have a sound plan.
How do you get into a situation where you need loan from family or friends? Credit card debt is the cause, in most cases, but things like not having a budget, overspending on rent or food, unforeseen medical bills, can quickly put you in a deep financial hole.
It’s best to intricately review your finances, looking for ways to cut back or eliminate unnecessary expenses and put the extra money in an emergency fund. Creating a budget and sticking to it, is essential.
Once you’ve taken steps to manage your debt, if a family or friend wants to help, by all means accept their advice and expertise. Determine the amount of money needed to eliminate the debt and calculate the monthly payments you can afford.
From there, it’s time to execute your action plan.
Expect some empathy from your “lender.’’ After all, your parents, siblings or closest friends want to see you succeed. They likely are willing to help you achieve your goals.
Don’t use that familiarity as an excuse for a non-professional approach. It’s not like a beefy business plan is needed, but the loan should be clearly structured in writing.
The proposal should include:
Be prepared to show the lender your budget, the financial adjustments you have made to the budget and the expenses you expect to cover. That should clearly establish your ability to pay back the loan.
Your responsibility as borrower is largely common sense: pay back the loan on time.
Don’t spend money on costly purchases or eat at expensive restaurants. Definitely don’t flaunt any purchases or nights out on Facebook while you are in the process of repaying a loan because it will only create resentment with the lender.
Even though it’s a loved one, always keep written records of your payments. Sure, there’s trust, but it’s even better to have formal statements for reference, just in case there are misunderstandings.
“Document everything,’’ Beyer said. “As each payment is made, initial next to the amount or send a confirmation note if not done in person. It may seem a bit formal, but you will be thankful when a dispute arises over how many payments have been made to date.’’
If you come into some extra money — such as a tax return — you should use it pay down the loan. That good-faith gesture will go a long way toward establishing credibility.
Parents, siblings or good friends lending money have every right to treat the loan like a business transaction.
A clear repayment schedule should be obtained. Communication is key. Make sure everyone understands it’s a loan, not a gift. Agree upon terms, then enforce them, if necessary. Document everything on paper. It makes things so much easier in the event of a conflict.
According to the Federal Reserve, most loans from family and friends are used to start a business or purchase a home. But sometimes, family loans can serve as a friendly form of debt consolidation, where you pay off your credit cards and make one, low monthly payment to family.
It’s popular these days to utilize peer-to-peer lending sites or maybe a crowd funding or GoFundMe approach. Either way, the nature of the relationship usually determines someone’s comfort with asking for a loan.
“Neither a borrower nor a lender be,’’ William Shakespeare wrote in Hamlet, circa 1603. Money matters were less complicated then, but the concept was still sensitive.
“Lending money to friends should be done with caution, if at all,’’ said financial expert Ric Edelman, an author and syndicated radio host. “You could lose your money — and your friend. So be careful.’’
Rivers already knows that sinking feeling. She said she’s working extra hard to make sure her parents will be repaid on schedule.
“I want to help myself,’’ Rivers said. “It’s nice that I can get help, but I don’t want to take advantage of that. They probably would’ve given me the money. I don’t want that. I hope this is the last time I will need to do this.’’
Grandstaff, M. (2016, 13), USA Today, Asked to co-sign a loan? When to say no (even if it’s your kids). Retrieved from http://www.usatoday.com/story/money/personalfinance/2016/07/13/co-sign-on-loan-lose-money/86212568/
NA, (2013). Survey of Consumer Finances, Board of Governors of the Federal Reserve System. Retrieved from http://www.federalreserve.gov/econresdata/scf/scfindex.htm
Gunn, E. (2011, 24 May), Five Tips for Asking Friends and Family for Funding. Retrieved from https://www.entrepreneur.com/article/219693