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Knowing how to borrow money from a friend or family member could be a much better way of getting financing than institutional loans, and you probably don’t need a credit check. But whether it’s a smart way to borrow depends a lot on how you handle your debts.
Getting a loan from a friend or family member can be a fraught process, both financially and socially. Yet if you and your “lender” are clear on your terms, and take the loan seriously, it can be a smart move for everyone.
These 11 steps will teach you how to borrow money from friends and family, reaching a mutually-beneficial arrangement that your relationship will survive:
1. Look at all your borrowing options
2. Consider the financial and social risks
3. Ask the right person
4. Discuss all the loan details
5. Create a loan repayment timeline
6. Find a loan mediator
7. Insist on paying interest
8. Don’t overcommit yourself
9. Finalize the agreement — and put it in writing
10. Make payments on time, every time
11. Actively communicate about the loan
Before you jump right into borrowing money from friends, consider if there are other personal loan options you can turn to first. For many reasons, it might be better for you to borrow from a bank or financial institution rather than from an individual you know.
You can even ask for financial help besides a loan. For instance, you can ask the person to be a cosigner on a loan if you have bad credit and wouldn’t qualify on your own. Or you could see if they’d be willing to supply the savings collateral for you to take out a savings-secured loan.
If you run out of options, you could consider alternatives, such as crowdfunding or borrowing from a peer-to-peer lender.
|Pros and cons of borrowing money from friends and family|
|● Keeps you off the doorstep of predatory lenders|
● Potentially lower interest rate (and generally, more lenient repayment terms) than you could have secured from traditional financial institutions
● Small-amount loans between friends can be funded immediately using slick tools like Venmo and Google Wallet
|● Potential awkwardness or hard feelings|
● Lack of clarity on loan terms can cause confusion, argument
● Absent loan documentation can leave both parties unprotected legally
● Successful payoff won’t directly improve your credit profile
● Repayment gone awry could harm your personal relationship*
|*According to a 2017 Bank of America survey, 53% of respondents said they’ve had a friendship end because of money owed.|
Make sure you also understand the risks of borrowing money from friends and family, and that you’re willing to face them. This type of loan will have all the same risks as other debts.
You “will be entering a legally binding contract allowing (the lender) to sue if (you) breach any of the repayment terms,” said Shaolaine Loving, a Las Vegas attorney.
There’s also the added risk of damage to the relationship. You can’t afford to just assume that everything will turn out well. Make sure you are prepared to borrower responsibly to avoid damaging the relationship.
And consider the person you’re borrowing from. Even if you’re a perfect borrower who never missed a payment, your lender might struggle to separate the loan from your relationship.
“Many people feel awkward about borrowing money from a family member or friend, but if you handle the business transaction correctly, it can be a win-win for both of you,” said Carla Dearing, a former financial wellness company CEO.
If you’re wondering how to ask to borrow money, ensure it’s the right person.
From the start, you need to be considerate of the other person’s financial situations and obligations. Asking for a loan from someone who can’t afford to give it or who doesn’t trust you will just put everyone in a tough and awkward position.
Don’t ask to borrow money from a friend or family member who you’re not confident can afford to give you a loan. It would also be appropriate to limit your requests to people with whom you have a positive and close relationship.
Just as when finding a loan cosigner, be wary of not-so-close friends and family jumping at the chance to serve as your lender. They could have an ulterior motive.
When you ask for a loan, you need to be upfront about everything you need and are asking for. Make sure you cover all the loan details, such as the initial balance, how it will be repaid and other loan terms.
“For example, whether you want any interest or late fees to append, and whether the repayment will be in installments or in a lump sum,” Loving said.
Additionally: “The discussion should include that the person borrowing can actually afford to pay back the loan, and by when,” said financial advisor Lisa Chastain. Make sure you cover “what will happen if the person fails to pay back the loan.”
Preparing for a worst-case scenario before it occurs puts you in your best position to handle it.
If you’ll be making installment payments on the loan, outline the full schedule and share it with the lender.
“Knowing when to expect your payments and when the loan will be repaid in full should ease any anxiety your family member or friend may have,” Dearing said.
“You show your gratitude for the favor of the loan by making repayment as transparent and stress-free for [them] as possible,” she added.
As you’re hashing out the details of the loan and how to set it up, it can be helpful to get a middleman involved.
“Find someone who is a neutral party who can help you reach terms for both parties,” Chastain said. “Be sure that each party feels like they are getting a good deal, and agree to specific terms, conditions and a payback plan for the loan.”
Be wary of negotiating terms. If your familial lender wants to charge a certain interest rate, for example, that’s their prerogative. As the borrower, evaluate other lending options the same way you would if you were shopping around for a personal loan among banks.
Another show of your good faith as a borrower is to pay interest on the loan.
“Insist on paying interest at a rate of at least what your family member/friend would earn if he put the money in a high-yield savings account,” Dearing said.
After all, this is a favor to you — and paying interest ensures it financially benefits both parties. You will probably get a lower interest rate than a bank would offer, and your lender can see their money grow.
“With bank rates as low as they are these days (below 1%), by asking for a loan and offering to pay 2% or 3% interest, you could be doing your family member a favor,” Dearing said.
At every stage, you have to be realistic about your loan and ensure you don’t borrow more than you can afford to repay. Your relationship will depend on it.
“The borrower should only agree to terms that [they think they] can uphold,” Loving said.
If you’re worried you’ll hit bumps down the road or be unable to repay the loan at any point, that’s a red flag. Go back to the drawing board and rework your agreement until you’re confident you can uphold your end.
“Protect the personal relationship by creating a clear and fair repayment plan upfront,” Dearing said. “Put it in writing — and then stick to it.”
Like the master promissory note on federal loans, a customized promissory note is a common way for two individuals to formalize a loan agreement. Getting your loan terms in writing will protect both your interests and the lender’s.
“An agreement will allow you both to be clear on expectations so that you don’t prematurely expect payment and feel bitter about nonpayment if terms aren’t outlined from the start,” Loving said.
Once you agree on the loan and the funds are handed over, be diligent about making payments. You can even check if your bank allows you to set up automatic direct deposits or transfers.
“The borrower must not think that just because it’s a friend or family member that it will be OK if [they do] not pay on time and according to the terms of the loan,” Chastain said. “Treat the relationship just as they would if it was a bank or official lender.”
As you pay off the loan, you should also try to be proactive and communicate regularly about your loan. For example, get your lender to send you confirmation of payment each time they receive funds from you. This will help protect you from any errors, as well as catch any transaction issues.
And if you ever run into issues, talk to your friend or family member right away.
“If it turns out he cannot make payments as promised, then he should approach you promptly with a realistic proposal of alternative payment options,” Loving said. “That way, the borrower doesn’t come off as trying to shirk [their] obligations.”
Andrew Pentis contributed to this report.