Personal Advice

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Lending Money to Family or Friends

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 those checkered credit issues in your past.
  • They may be more flexible with how you pay it back.

However, there could also be a downside of borrowing from friends or family too, and that is that it could damage your relationship if you are unable to pay it back. Therefore, there 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 say yes to lend the money if you mean it. Do not extend a loan to a friend just because they made you feel sorry for them. If you do not want to lend the money, turn them down. Turning down a loan request does not make you an inadequate friend or selfish. In fact, you may preserve your relationship by not lending the money.

If you do end up lending them money when you are not sure you want to, you may end up feeling resentful later on, and that can damage your relationship with them.

Also, 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 will 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. You can at least expect to harm your relationship.

Preserving the Relationship

When you ignore or break a loan agreement, the relationship that you have likely built for years or decades can crumble. Therefore, you need to keep communicating with your loved one if you fall behind on payments. By keeping in touch with them, you avoid animosity.

Both of you should enter into the loan realizing there could be problems and decide ahead of time 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 will be less stressful and much more straightforward.