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Borrowing from family and friends

Thursday, 14 January 2010

When some people find themselves in a "cashflow situation", a natural reaction for many is to turn to family members or friends for help. Parents, brothers, sisters, grandparents, in-laws etc. can be more than happy to give you a helping hand and give you the loan you need. The reasons behind asking for this loan could be for a whole host of reasons. Loss of income arising from unemployment, a deposit required for a house purchase.

Question: How many kids ask their parents for this? Answer: An awful lot and many parents actually borrow this money from their own bank so a third party can also be involved. Money can also be sought for a business venture, refusal by a bank to lend money and the list can go on and on.

Borrowing money from relatives however if not handled carefully could result in not just the family member being resentful if it is not paid back but others too.

It is important to note that there is no such thing as a family loan without the emotional ties. If you do not realise and understand this from the outset then you are in for a surprise.In the USA according to the Federal Reserve they estimate there are over 7 million outstanding loans between friends and family members at any given time. They also found that many small business owners rely heavily on funding from family or friends mainly because it was available and inexpensive.

Liam Croke

Liam Croke is a financial and mortgage adviser. He has worked in the financial services industry for 18 years, and has also written a book on financial planning called "Your Money, Your Life"

1. Document the loan terms.

Verbal agreements and handshakes are never enough. Relationships can be ruined due to misunderstandings about the loan terms. If you don't write down the terms such as the loan amount, an interest rate if there is one, when the loan is to be repaid in full, how frequent you make repayments and so on, then one of the parties is liable not to fully understand the agreement.

Don't be embarrassed about asking for this to be put in writing particularly if you are the one lending the money regardless of the relationship to the person you are lending the money to. This document will provide clarity to all involved and no misunderstanding about "you thought" or "I thought" will occur in the future.

It may be sufficient in a very simple transaction to write a letter that specifies the terms of the agreement and one that can be signed and witnessed by you both but the best way is maybe to get a solicitor involved particularly there is a significant amount of money involved.

2. Set up a repayment plan.

Agree on a rate of interest and I would encourage you if you are the "lender" to charge some rate on this loan. It may be just 1% but at least it is something but make sure it is fair to both parties involved.

3. Avoid "balloon payments".

Lump sum repayments are sometimes referred to as balloon repayments and are a common feature in many car loans/leases these days. They are a lump sum repayment at the end of the loan term but they are very risky for both the borrower and lender. Borrowers inevitably cannot save enough to make the balloon payment which is why I suggest setting up a regular repayment plan form the outset.

4. Be fair and open.

If the loan is between a parent and child then point out that the arrangement is formal and is not a gift. Be prepared for other siblings to find out about this loan so you are going to have to offer a similar deal to them so jealousy doesn't arise. Also, hiding a private loan from a spouse or partner is asking for trouble.

The least recommended way to borrow money is from friends or family. If you don't repay a loan on time or you are in arrears with a bank you can do so without the risk of permanently ruining a relationship, your credit rating maybe but not a friendship. If you have to use a family member or friend to borrow money from, then make sure that this is the first bill you pay each month!