It might be the most loaded of all loaded questions. But for someone who can’t secure a loan from a traditional lender, it may feel like the only other choice is to consider borrowing money from friends or family.
If you’re weighing the pros and cons of either borrowing money or lending it, you’re not alone. A recent Bankrate survey asked nearly 2,500 Americans whether they had ever lent money to friends and family, and a full 60% of them said that they had given someone cash to help them out. More than a third of respondents, though, said the situation ended badly.
This article breaks down the advantages and disadvantages of borrowing money from family and friends, offers some tips on lending money to friends and family, and looks at other options that may be less common alternatives.
If you’ve ever taken out a traditional loan, you’re likely to notice some big differences between dealing with a bank and dealing with people you know. If you borrow money from a friend, it’s likely to be an informal process that doesn’t involve providing a wealth of documents to prove your income, possible loan origination fees and perhaps going through a credit check.
If the amount is small enough, they might just Venmo the funds to you.
A friend or family member is also more likely to be flexible about when they need the money back, how you pay it back, and whether or not they want interest. Whereas a lender might have formally written terms and conditions, your friend may be more likely to say, “Whenever you can get it back to me is fine.”
Avoiding the funding gauntlet that comes with using a big-name lender may be especially beneficial for entrepreneurs and independent contractors who may have a hard time getting loans via traditional means. Borrowing from a friend or family member might also be a good way to work in a grace period to focus on getting a new venture off the ground before repayments start.
William Shakespeare may have been onto something when he said, “Neither a borrower nor a lender be.”
The disadvantages of borrowing money from family and friends can be more emotional than monetary. For example, if they back out of giving you the money or you aren’t able to repay them, it can seriously damage the relationship.
In marriage, money is the second most common reason couples divorce. But breakups can apply to friends and relatives, too, especially if finances get in the way. Imagine trusting a family member or friend, fronting them the cash, then having to bug them to get it back. Awkward.
Another issue that can strain a relationship is a lack of clarity over what the loan entails. A friend who loans you money to launch a new business might assume that their investment is just that – an investment. They may think it entitles them to royalties down the road, commission or even partial ownership.
Finally, it can be downright embarrassing for many of us to reveal a financial hardship to a friend or family member. A survey from Capital Group found that Americans would rather talk with their friends about religion and politics than money.
Finding yourself on the receiving end of a money request can be equally sticky. In fact, 53% of Americans said they wouldn’t loan money to a family member or friend, no matter how small the amount. It’s not necessarily a surprising figure if you consider the common perception that personal lending situations are doomed to fail.
Lending money informally not only puts you at risk of ruining the relationship if the agreement isn’t upheld, it can also find the lender in financial distress. In the same Bankrate survey cited above, 37%of respondents said they lost money after loaning it to a friend or family member, and 21% said their relationship was harmed.
If you say yes to helping a friend out, one of the best ways to keep everything on the up-and-up is to set clear expectations on how and when you expect the money to be returned. Do you expect interest? Do you need the money back by a certain date?
Or, do you need the money back at all? Considering the money as a gift vs. a loan is a good news/bad news situation: It can take much of the pressure off the arrangement, but it can also be taxable. Be sure to do your homework and ensure that any money you lend isn’t going to hurt you come tax time.
The key to lending or borrowing money and remaining friends afterward is to handle it with care. It is possible to successfully bring money into a personal relationship if everyone lays everything out on the table from the get-go.
Here are a few things to consider as you have that first conversation:
The first thing you can do, as a borrower, is to be transparent and honest with your potential lender. Be clear about:
- How much money you need
- Why you’re asking them for the loan vs. a traditional lender
- How and when you’ll be able to pay it back
- How you plan to use the cash.
That last tip is especially important because the people in your life can see first hand how you spend their money. As your lender, it may make a friend or family member feel like they have more right than usual to make judgments about how you spend your money and they might have something to say about it if they loan you $10,000 to launch an online business, then you head to an all-inclusive resort a week later.
Another way to make sure your friendship stays intact is to answer any questions honestly and to the best of your ability.
Finally, if you’re asking for money to jumpstart an online business is your goal, will your lender be considered a partner? Because of the flexibility in this type of arrangement, you may even want to consider offering your friend or family member a stake in your business instead of straight repayment of the loan.
Many of the same considerations apply here but from the other side of the coin. If you’re going to lend money to a friend or family member, what are your expectations? Do the suggested repayment terms work for you? If you’re uncomfortable with anything, be sure to speak up and come to a plan that’s agreeable for both parties.
In addition, consider how much money you’re willing to part ways with forever in case your friend or family member just can’t pay you back. An adage applies here, too: Don’t put in what you can’t afford to lose.
If they’re asking for an amount that’s too rich for your blood, it doesn’t have to be a deal-killer. Consider negotiating down to an amount that’s more comfortable for you. Or, if you trust that you’ll be paid back, asking for interest could be a way to lend a larger amount with confidence. (It can also help you avoid a gift tax.)
Finally, be wary of co-signing a traditional loan with a friend. Although it may give them a huge leg up, you’re on the hook if they fail to repay the loan. This could not only affect your bank account but your credit score. The same advice can apply when co-signing for a credit card. Your name on the agreement, regardless of the informal arrangement you make, means you’re legally responsible – and nothing kills a credit score quite like defaulting on credit card payments.
Even if you’re in complete agreement about the logistics of a loan, it can behoove everyone to have an attorney draw up a legally binding promissory note. Adding a formal contract to the mix can go a long way to helping everyone feel more comfortable about the situation. The promissory note works much like a traditional loan with specifics like:
- Repayment terms
- Interest rates
- Penalties for late payments
- Provisions for what happens if the borrower defaults
Finally, consider the larger impact that a loan could have between the two of you. If you give money to one family member – how long until others ask for the same? If you ask for money from a friend or family member, could it change your perception within your circle? One way to avoid relationship side-effects is to keep the transaction completely confidential.
You may feel like asking friends and family members for cash is your only choice, but there are some other options you can explore if a traditional lender says no.
Microlending: If you need an influx of cash for a small business, you may qualify for a small loan to help you get going. Organizations like the Small Business Association can help business owners get microloans of up to $50,000 with six-year repayment terms.
Crowdfunding: It may feel like everyone has a Kickstarter page these days, and if you have a mission that you feel the general public could get behind, you may consider setting up a crowdfunding page. If you go this route, you’ll want to be sure and make a clear case on your page for why you need the money and what you’ll use it for.
Peer-to-peer lending: This form of lending allows borrowers to connect directly to a marketplace of potential lenders by submitting a form on an aggregate site. If your creditworthiness is good, you may even find yourself in a bidding situation between several lenders, and the money is yours to use however you like. Several online platforms offer this type of loan, and while you may see higher interest rates from P2P lenders, they may still be much lower than your current credit card rates.
Borrowing money from friends or family can be tricky. If you’re considering a loan to help pay off credit card debt, check out Tally. This debt-payoff app can show you the big picture in one place. Knowing exactly how much you owe, to whom you owe it, and how much you’re paying in interest is the first step toward paying off your debt faster. Tally* may even be able to help you get a lower interest rate if you qualify, so you can reach your debt-free goals faster.
*To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. Based on your credit history, the APR (which is the same as your interest rate) will be between 7.90% – 29.99% per year. The APR will vary with the market based on the Prime Rate. Tally Technologies, Inc. NMLS # 1492782 (nmlsconsumeraccess.org). Loans made or arranged pursuant to a California Finance Lenders Law License or other laws in your state.