Polonius in William Shakespeare’s Hamlet said that mixing loans and relations was damaging because “for loan oft loses both itself and friend.”  But how dangerous is it to loan/borrow from friends and family?

Let’s look at some advantages and disadvantages of borrowing from family and friends:

Pros:

• Low interest rates, if any
• Instant access to money
• Banks are tight, only means to obtain funds

Cons:

• Relationship is jeopardized if loan is not paid
• Financial situation is no longer private
• No protection due to not being formal

Financial transactions between people with personal ties tend to muddle a relationship. What once was purely a friendly or familial connection now takes on elements of a business transaction.

Furthermore, very few use business contracts and documents to formalize the transaction. Because of the relationship, the lender becomes uncomfortable laying out the agreements formally. They do not want to “taint” the emotional relationship.  This, of course, just leads to bigger problems.  Life happens (lay-offs, natural disasters, etc.) and without formal documentation, both the lender and borrower are not protected when these events occur.

In October of 2008, The New York Times published an article entitled Mixing money and family in the US where the author, Christine Haughney, demonstrated that loans between family members has increased since the banks have tightened their lending standards.  For many young adults, the only way they can purchase a home/car or get out of debt is to borrow from relatives.

While the pros and cons are neck and neck, it should be noted that each of the cons weighs a bit more than each pro because of the emotional relationships involved.  But several sources list guidelines that help lessen the impact of the issues addressed in the con category.

One of the most common guidelines when mixing “love & money” is to not make it a loan.  If you, the lender, make a financial gift, then there is no expectation of repayment.  Thus the relationship is not strained.

The other most common guideline to loaning/borrowing from friends or family is to document, document, document!  There are inexpensive (and some free) loan document templates available online that individuals can use to keep the whole loan on the “up and up,” such as Net Lawman and Law Depot.

If you do decide to ask for money or loan money, here are a few things to consider:

For the borrower:

• Borrowing should be the last resort (eliminate all non-essentials in your life)
• Gauge the risk of the loan coming between you and your family
• Figure out exactly how much money you need before asking
• Prepare a budget to determine how much you can comfortably pay each month to repay the loan
• When you ask the family member or friend, spell out exactly what the money will be used for and provide financial documents that show your income and expenses to prove you can repay the loan
• Prepare a formal loan document that spells out the terms of repayment and remedies for default in the loan
• Do not expect special treatment.  This is business.
• Avoid wastefulness while the loan is outstanding

For the Lender:

• Make a gift instead of a loan
• Don’t lend money you can’t afford to lose or do without
• When possible, gift/loan needed items instead of money
• Make sure your family member or friend is able to make monthly payments to pay you back
• Prepare a formal loan document that spells out the terms of repayment and remedies for default in the loan
• Don’t co-sign for anything unless you are prepared to pay off that debt yourself.  If you have co-signed, keep track of the payments that have been made
• Do not expect special treatment.  This is business.

Ultimately, each person will have to weigh the pros and cons of borrowing/lending to family members or friends and make their own decisions.

Photo by SuziJane

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4. How NOT To Get Screwed on a Debt Consolidation Loan
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