If you’re trying to apply for a personal loan with bad credit and can’t get approved, borrowing money from friends and family might be a last-ditch option. But is that an option you really want to consider?
Accepting a loan from a friend or family member can be a stressful process, both financially and socially.
“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,” says Carla Dearing, co-founder and CEO of SUM180, an online financial wellness service.
However, if you and your lender are clear on the terms and take them seriously, it could be a worthwhile money move for everyone involved.
11 steps for borrowing money from friends and family
By following these 11 steps for borrowing money from family or friends, you’ll be able to reach a mutually-beneficial arrangement that the relationship will survive.
Take a look and see if this 11-step process is feasible for you.
1. Look at all your borrowing options
Before you jump right into borrowing money from friends, consider if there are other personal loan options you can turn to first. For instance, it might be better for you to borrow from a bank or financial institution rather than an individual you know.
That way, if you have a hard time paying the money back, you can deal with a lender that has money in the bank. You also avoid putting someone you care about in a financial bind.
Or, instead of financial help, you ask this person to be a co-signer on a loan. This can help you out if you have bad credit and wouldn’t qualify on your own.
Additionally, you could see if they’d be willing to supply the savings collateral for you to take out a savings-secured loan.
2. Consider the financial and social risks
Make sure you also understand the risks of borrowing money from friends and family, and that you’re willing to face them.
Remember, this type of loan will have all the same risks as other debts. And according to Shaolaine Loving, a Las Vegas attorney, you “will be entering a legally binding contract allowing [the lender] to sue if [you] breach any of the repayment term.”
There’s also the added risk of damaging your relationship with this person. You can’t afford to just assume that everything will turn out well. Therefore, make sure you are prepared to borrower responsibly to avoid hurting the relationship.
3. Ask the right person
From the start, you need to be considerate of other people’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.
Therefore, 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 asks to people with whom you have a positive and close relationship.
4. Discuss all the loan details
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.
Additionally, Loving says you should discuss “whether you want any interest or late fees to append, and whether the repayment will be in installments or in a lump sum.”
Money coach Lisa Chastain says, “The discussion should include that the person borrowing can actually afford to pay back the loan, and by when.”
Most importantly, Chastain says to make sure you cover “what will happen if the person fails to pay back the loan.”
5. Create a loan repayment timeline
If you’re 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 says.
“You show your gratitude for the favor of the loan by making repayment as transparent and stress-free for him or her as possible,” Dearing adds.
6. Find a loan mediator
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,” suggests Chastain. “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.”
7. Insist on paying interest
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 suggests.
After all, this is a favor to you – and paying interest ensures it financially benefits both parties. At the end of the day, you’ll 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 (one to two percent), by asking for a loan and offering to pay four or five percent interest, you could be doing your family member a favor,” Dearing explains.
8. Don’t overcommit yourself
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. That’s why Loving says borrowers should only agree to terms they think they can uphold.
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.
9. Finalize the agreement – and put it in writing
“Protect the personal relationship by creating a clear and fair repayment plan up front,” Dearing suggests. “Put it in writing—and then stick to it.”
A promissory note is a common way for two individuals to formalize a loan agreement. Putting 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 points out.
10. Make payments on time, every time
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 okay if he does not pay on time and according to the terms of the loan,” Chastain says. “Treat the relationship just as he would if it was a bank or official lender.”
11. Actively communicate about the loan
As you pay off the loan, you should also try to be proactive and communicate regularly about your loan. 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 says. “That way, the borrower doesn’t come off as trying to shirk his obligations.”
Keep your relationship strong
Borrowing money from friends and family can be an affordable way to get a loan, and remove the hassle of credit checks and applications. But with a relationship on the line, you can’t afford for the arrangement to turn sour.
Take your lending arrangement seriously, follow these steps, and you’ll still be on speaking terms by the time you make your last payment.
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