Loans from family and friends stack up to nearly $90 billion annually in the U.S., according to the Federal Reserve Board’s Survey of Consumer Finances (SCF).
Lending or borrowing money can be a tricky thing when the transaction is with family or friends. There are several benefits of borrowing from a family member or friend.
- The friend or family member may offer more desirable lending criteria, such as lower rates or longer repayment period, for extending the loan than you can get from a traditional lender.
- The relationship you have with your family member or friend, and their knowledge of your situation may help move you past any checkered credit issues in your past.
- They may be more flexible with how you pay it back.
However, there could also be a downside to borrowing from friends or family too. It could damage your relationship if you are unable to pay it back. Therefore, here are some tips to follow when turning to family members to borrow or lend money.
Tips for Borrowers
Treat your loan from your friend or family member like you would if it were a loan from a bank. When borrowing money from a bank, you have a written contract stating that you must make payments each month on time until you pay the loan off.
That should not be any different when you are borrowing money from loved ones. Although it may take you years before you can pay them back, they still need to know that you will pay them back as you promise.
Agree to a written loan contract just like you would a professional lender. That will protect both you (the borrower) and your loved one (the lender) if there is a disagreement.
Tips for Lenders
Only lend out as much money as you can afford to lose. Even if your loved one says they are reliable, trustworthy and financially stable, things could happen where they may not be able to pay it back, and you will be out of that money.
Others things you should do include:
- Putting the loan agreement in writing.
- Creating a repayment timeline that's firm.
- Never letting the due date slide.
All these things will help prevent any confusion as to the terms of your agreement.
What Happens if the Loan Defaults?
If you are the lender, an essential thing you should include in your written contract is what you will do if your loved one does not pay you back.
If you are the borrower, you are legally responsible for paying back the loan, just like you would with any loan contract. If you do not abide by the contract's terms, your loved one (just like a lender) could take legal action and sue you in a small claims court where they can receive a judgment and pursue collection activities like property liens or wage garnishment. That is not to say they would, but they could. Be prepared for the potential to harm your relationship.
Preserving the Relationship
To help preserve the relationship that you have likely built for years or decades keep communicating with your loved one if you fall behind on payments. By keeping in touch with them, you can hope to avoid reduced trust.
Both of you should enter into the loan deciding that if there are problems what the response will be. By not having an action plan in place, emotions can run high, and you will end up in a heated argument over the debt.
By planning and taking precautionary steps, you can avoid hurting your friend's feelings and their bank account. Have everything in writing and lay all the expectations out ahead of time to keep things clear. When you put these tips into action, loaning or borrowing money can be less stressful and much more straightforward.