Lending money to family and friends ranks near the top of the list of things that shouldn’t be done without careful thought. And what, you ask, ranks just as high?
Borrowing from friends or family.
Let’s be clear: A loan from a relative/friend may be the best solution for your current financial need. Your credit may be unestablished or so tarnished that you can’t afford the interest rates traditional lenders would charge, and a friend or family member may be far more flexible than a business if paying it back takes longer than you planned.
But don’t think for a second that there aren’t potential pitfalls to this kind of arrangement. Money may not be able to buy relationships, but it can definitely ruin them.
If this is what you want to do, you need to know how to borrow money from family and friends.
Consider All Your Options
Before you borrow – regardless of whether it’s from someone you know or a business – ask yourself why you need a loan. The answer may be obvious and the need may not be your fault.
Then again, if you’ve been operating without a budget, paying too much for necessities or buying unneeded items, the best first step is to get control of your spending. Creating a budget and sticking to it is great advice for anyone. Finding ways to earn extra income is another key step. You may discover you don’t need to borrow. Or, if you do, you’ll be better equipped to pay a loan back promptly.
Look at all your borrowing options. Banks and other financial institutions, both brick-and-mortar and online, may have rates and terms you can handle that don’t put a loved-one in a financial bind. That friend or family member might be willing to co-sign a loan or provide collateral if you can’t otherwise qualify.
Again, understand the risks of borrowing from someone you care about. Things don’t always turn out as planned. How much is that relationship worth to you?
How to Ask Family and Friends for Financial Help
So, you’ve weighed the risks and rewards and decided your mom or BFF is the right bank. Now, you need to consider how to do it with the greatest likelihood of success. Most people are wary when it comes to their money. Love and trust are not synonymous.
If you’re borrowing to pay a bill you owe, consider asking your friend or relative to pay the bill directly rather than pay you. That way, they know how the money is actually being used instead of wondering if there’s a different agenda.
Continue to communicate while you’re paying off the loan. Assuming you are paying in installments, ask for them to confirm receiving each of your payments to minimize any disputes about how much you still owe. If you’re going to be late with a payment, let them know in advance, explain why and tell them when to expect their money. It’s important not to appear to be dodging your responsibilities.
4 Tips to Navigate Borrowing from Family and Friends
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:
- The amount to be borrowed (principal).
- Interest rate (You should offer, even if they’re likely to decline. For a long-term repayment, 2% to 4% is reasonable.)
- Repayment terms (either monthly installments or a lump sum).
- The lender’s course of action if there is non-payment (such as adding additional costs to the loan, modifying the loan terms or taking collateral). It’s wise to establish a contingency plan if there are problems repaying (such as extending the term or lowering the payments).
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.
Set Fair Terms and Sign an Agreement
Did we tell you to put this in writing? We did. We’ll say it again: Put it in writing. Memories of what people promised can vary. The written word doesn’t. Even though it’s a relative or friend you’re borrowing from, treat this professionally.
Create clear terms of repayment. This communicates your commitment to making payments and boost’s your lender’s confidence. Terms should include when you’ll start paying them, how much and how often you’ll pay, how the payment will be made, when each payment will be due and when the loan will be paid in full. Include what happens if you miss or are late on a payment; offering to pay a late fee is advisable. You may consider offering something valuable as collateral. When both parties settle on the written terms, both should sign the document.
Outside the letter of the agreement, use common sense. 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. Always keep written records of your payments.
Choosing Whom to Borrow From
Just because your relative loves you and your friend likes, you is not enough. Take into consideration the other person’s financial situation. Don’t try to borrow from someone unless you’re sure they can afford it. Their sense of obligation to you might cause them to put themselves at risk. It’s bad enough that you’re in need. Don’t put them in the same boat.
Only Borrow What You Can Repay
Because it’s a relative or friend instead of a financial institution, it’s easy to think to casually about this. But it’s not casual; it’s money. Don’t borrow more than you can afford to repay. If you’re doubtful, borrow less. Borrowing and not repaying will put a blowtorch to that relationship.
Make All Payments, and Make Them on Time
How reliably you make payments will be seen as a reflection of how you value your friend or family member. If you miss payments or are late, it will be interpreted as disrespect. Again, this relationship has value. Make it easy for you to do this the right way. Schedule automatic transfers online if possible. Set a reminder on your digital calendar. If you can, pay it off early. Your relationship might actually be enhanced.
When a Family Member Wants to Borrow from You
You should be just as careful if a friend or relative wants to borrow from you. Don’t loan more than you can afford to lose. Talk with the borrower about budgeting, finding additional income and whether there are better borrowing options. If you want to receive interest, set a fair rate. Treat this as a business transaction; create a payment schedule and get everything in writing. Being the lender instead of the borrower doesn’t change the risk of ruining the relationship, so think this through and make sure you’re comfortable before agreeing.
Talk to a Professional
No article can cover all the potential pitfalls of lending or borrowing. If you’re short of money – and especially if this is often the case – it might be a good idea to seek credit counseling, which can help you discover and deal with the bigger financial picture instead of just the immediate need.
And it won’t risk your feeling unwelcome at the family reunion.
- Kirkham, E. (2017, March 13) 11 Steps You Need to Follow If You Borrow Money From Friends or Family. Retrieved from https://studentloanhero.com/featured/borrowing-money-from-friends-and-family/
- Hayes, A. (2020, June 24) 8 Rules for Borrowing Money From Friends and Family. Retrieved from https://www.consumerismcommentary.com/rules-borrowing-money-friends-family/
- Williams, G. (2018, August 14) A Guide to Borrowing Money From Friends and Family. Retrieved from https://money.usnews.com/money/personal-finance/family-finance/articles/2018-08-14/a-guide-to-borrowing-money-from-friends-and-family
- Pascarella, D. (ND) The Right Way To Borrow Money From Friends And Family. Retrieved from https://www.forbes.com/sites/danipascarella/2018/11/26/the-right-way-to-borrow-money-from-friends-and-family/#6a89b86b32a5