For many people, a friend or family member will be one of the first ports of call when they hit financial trouble. In some cases, this can be a cheap and easy solution, but all parties should be aware that it comes with both financial and personal risk. In this article, we explain how loaning money to family and friends works, how to avoid the major pitfalls and what alternative options are available.
Loaning money to family and friends
Getting a loan from friends or family could be a low-cost option to cover an unexpected expense or to get you through to your next payday. It is usually cheaper than getting a loan from a mainstream lender and will not necessarily require a strong credit history. Depending on how much cash the person lending has access to, it can also be quicker than going to a bank or online lender.
Despite this, loaning money to family or friends carries a whole host of potential issues. Making sure the money is repaid on time and in full is important with any loan, but takes on a different weight once a friendship or family harmony is on the line. What’s more, any disagreements or arguments you may occasionally have with that person will be amplified once there is money involved. It can be a tricky relationship to navigate and one you should be sure to go into knowing what can go wrong and the best ways to mitigate the potential disasters.
Tips for loaning money fairly
If you are thinking about loaning money to family or asking to borrow money yourself, ensure you stick to these tips:
Make sure you can trust each other
Whether you are lending money or borrowing money, you should make sure the person you are dealing with is trustworthy. Even if they are someone you have known for a long time or are closely related to, that does not mean they are the right person to enter into a financial agreement with. Dealing with the wrong type of person could land you in serious trouble, especially if they begin to miss repayments or try to change the loan agreement to hike the interest rate.
At the same time, make sure you behave in an appropriate way too. It would be wrong to try and pressure your friend or family member to agree to terms that are overly beneficial to you, or to use your existing relationship to push to borrow more than they can afford to lend.
Decide on a budget
It is important that both parties know how much they can afford to borrow and how much they can afford to lend. When deciding how much money to borrow, it is always best to stick to the amount that you need. This means working out a budget for what you intend to use the money for, whether that is everyday costs until you next get paid or emergency repairs to your home.
If you decide to lend money to a trusted friend or family member, you need to make sure you are not overstretching yourself. No matter how much they might need the money, it will usually only make the situation more challenging if you damage your own finances too.
You should both agree on how much is affordable to repay each month and therefore how long it will take to pay all of the money back.
Set out a loan agreement
This is something that many people loaning money to family or friends may be tempted to skip, but it is a critical part of setting up a fair repayment plan. While it may feel like your relationship is close enough to not need a formal agreement, in reality the closer you are, the more important a robust plan becomes.
It should include basic details such as the loan amount and rate of interest, a detailed schedule of what each repayment will be until the loan is paid off, and what happens if any repayments are missed. You should also set out what will happen in the event of extreme circumstances, such as one of the parties dying before the end of the loan term.
This formal agreement does not mean that you do not trust one another or you think the other person is going to go back on their word. Personal and financial circumstances can change quickly, so having a strategy in place to deal with such scenarios is just good planning.
Put everything in writing
Agreeing to how the loan will work is not enough. A verbal contract may seem sufficient between close friends or family, but it is much better to have a solid written plan explaining all of the key details. It can become a crucial reference tool to solve any disputes and protect everyone involved.
In some cases – such as loaning large amounts of money – it can be a good idea to seek out professional help to put your agreement in writing. This will reduce the chance of any serious disagreements, but should also help if anyone wants to make changes to how the loan works.
Record each payment
Every payment made should be recorded and acknowledged to ensure everyone knows that the repayment plan is progressing as it should. This will help avoid any innocent misunderstandings developing into arguments, even if it may feel tedious at times.
Pros and cons of borrowing money from family and friends
Here is a summary of the key pros and cons of loaning money to family or friends:
Pros of borrowing money from family and friends
- Less interest to pay - It’s pretty safe to assume that the interest rate on a loan for family or friends will be less than the market rate. This means that the person borrowing should save money and the person lending – if they do decide to charge interest – is still getting a return.
- Increased flexibility - You can work out the loan terms that work best for both parties, without having to stick to a loan provider’s rigid layout.
- Credit is less important - Loaning money to family and friends does not involve credit checks or affordability checks, which can help people who would struggle to borrow elsewhere.
Cons of borrowing money from family and friends
- Relationships can break down - Missed repayments, disputed terms and other disagreements related to the loan will likely strain your relationship.
- There is risk - Working away from mainstream lenders means there are more things that can go wrong
- No credit-building mechanism - Usually repaying a loan on time will improve your credit score by filling your credit file with examples of good borrowing behaviour. This is reliant on the lender reporting the repayments to a credit reference agency, which is unlikely to happen if the lender is a friend or family member.
What to do if loaning money to family and friends goes wrong
Before you commit to loaning money to family or friends, you should be prepared for things going wrong. There is always a chance, no matter how close the relationship, that the money may not be repaid. This means that the lender needs to be ready to either accept that they will not get their money back or be prepared to take additional steps to recover it.
In many cases, people who do not get money back from friends or family will choose to log it as a gift and move on. However, for others this will not be an option. The first step they should take to get their money back is to approach their friend or family member in an honest and direct manner. Try to come to a compromise solution that will make it realistic for them to pay the money back – such as a longer repayment schedule of smaller monthly payments – or agree to accept as much of the debt as they can afford to repay.
The most extreme option would be to pursue your – likely now former – friend or family member through the courts. You would need to apply to a county court to claim back the money you are owed. You will be expected to try and mediate first, but should that fail you will need to attend a hearing in a judge’s room or a courtroom in a county court. If you are claiming for more than £10,000, the procedure is slightly different.
Make sure you have all of the written records of your agreement and consider getting some legal advice before you start the process.
Alternatives to loaning money to family and friends
At its worst, loaning money to family and friends can be a complicated way to help someone access credit and a very quick way to ruin a relationship. Here are some alternatives you could try yourself, or suggest to someone who has asked to borrow money.
Loans
Some people may assume that it is impossible for them to get a loan because of their credit history or their financial circumstances, but that may not always be the case. Check out our ‘Compare personal loans’ page, where you can see the top deals currently available and check your eligibility without applying. This will tell you how likely you are to be accepted for the loan without impacting your credit score.
Some specialist lenders can help if you have a bad credit history, but keep in mind that these providers will charge higher rates than the big-name mainstream options. Make sure that you are not dealing with any payday lenders that charge astronomical rates of interest.
There are also simple steps you can take to improve your credit score and potentially open up better borrowing options in the future. You could even use a credit card to build up your credit history with a view to getting a loan once you have a good credit score.
Credit cards
A credit card can be a great spending tool and a flexible way of borrowing money, as you only repay what you spend. There are a whole host of different credit cards that can help you access cash, spread the cost of big purchases, consolidate debt and much more.
There are also credit cards on the market for people with bad credit and people looking to build credit. Just make sure you clear the balance before the end of the billing period to avoid being charged interest, or at least make the minimum payment.
