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Borrowing money from loved ones can be a huge help in certain situations. And it's been a lifeline for many during the coronavirus pandemic, according to the Pew Research Center, which found that 30% of folks in households that experienced income loss turned to family or friends to see them through.
Borrowing from those close to you can also be a double-edged sword, however. Failing to follow through on paying back your loan could result in hurt feelings and a damaged relationship. Here are five ways to make sure you're taking the proper steps when borrowing money from friends and family.
1. Look at the Bigger Financial Picture
Asking a friend or family member for financial help can feel awkward or put the other person in a difficult position. Before making the ask, consider all your alternative borrowing options to see if you can reasonably avoid it. Those with good credit might consider a personal loan or credit card to cover the cost. Interest rates may be higher, but it may still be a manageable way to get through it without asking friends or family for money.
What do you need the money for? Borrowing from someone you know to buy a new guitar amp or handbag may be unwise. It's an option to explore, however, if you're up against an unexpected expense like a costly home or car repair, or you're at risk of being evicted.
If you're hoping to borrow from family or friends to buy a home, know that mortgage lenders like to substantiate all large deposits. The loan will count toward your overall debt, which could affect your eligibility.
2. Be Realistic About How Much Money You Need
There are some situations that may require you to ask friends or family for financial help. Run the numbers to get a ballpark idea of how much money you really need to borrow. If you've suffered a job loss, for instance, eliminate any unnecessary expenses from your budget and factor in what you can expect from unemployment benefits. You may find that you don't need to borrow quite as much as you originally estimated.
Just make sure to be realistic so that you don't have to go back to your loved one to ask for more. You also want to make sure you don't borrow too much, which can create trouble of its own. You may end up owing more than you can afford to repay, especially if the person charges you interest on the loan. These are all factors that can compromise your relationship with the person as well as your financial health.
3. Know Who (and How) to Ask
Once you know how much money you need to borrow, think about the people in your life who might be in a position to provide financial help. A retired parent, for example, may be on a fixed income or have to draw from a taxable account to give you the support you need. Meanwhile, another relative or friend with a well-paying job may have more than enough in savings to offer a short-term loan. Be careful when making assumptions about another person's finances, and avoid asking someone who may jeopardize their own financial health in order to help.
Another thing to think about is your relationship history. If there's tension or volatility there, asking for a loan could be a recipe for disaster. If that's not the case, it's still wise to consider whether you've borrowed money from this person in the past. If so, was it a positive experience for both parties? If you decide to approach them again, be mindful that you aren't making them feel like an ATM. Clearly lay out your intentions for the money, along with your proposed repayment timeline. Offering to pay interest can also show that you want them to benefit from the transaction as well.
4. Create a Loan Contract
This step might be easy to overlook, but a simple loan contract can provide your friend or family member with peace of mind and make them feel more comfortable providing a loan. Having things in writing can also help keep both parties honest and prevent finger-pointing down the road that could ultimately hurt the relationship.
A loan agreement, often called a promissory note, is a legally binding document that outlines the terms and conditions of the loan. This can include:
- How much you're borrowing
- If the lender is charging interest or requiring collateral
- The repayment timeline
- How much your payments will be and when they'll be due
By signing it, you're acquiring the debt and giving the lender the power to take you to small claims court if you default. This may sound extreme, and it may be unlikely that things ever come to that, but it's important to understand that borrowing money from friends or family should be treated like any other loan. It's not typically necessary to get a lawyer involved, since you can create a standard promissory note using a template from an online legal services provider.
5. Prioritize Your Loan Payments
Whether you're borrowing money from a bank or a loved one, making your payments on time should be a priority. Again, your loan agreement should outline how much you'll be repaying each month and when. Treat this as a regular line item on your budget. You can even consider setting up automatic monthly bank transfers so that it's out of sight, out of mind (just make sure you have enough cash in the account to cover it). Alternatively, your friend or family member may prefer a check or to be paid with an app like Venmo or PayPal.
If you hit an unexpected financial hurdle along the way, be upfront with them as soon as possible, especially if they're relying on your monthly payment. Your willingness to find a solution and right the ship quickly may be enough to keep the relationship intact.
The Bottom Line
The potential complexity of borrowing from someone close to you underscores the importance of having a healthy emergency fund you can draw on when disaster strikes. Maintaining strong credit is equally important as it can help you qualify for reasonable financing so that you don't have to ask friends or family for money. Free credit monitoring with Experian can help you identify potential fraud and protect your credit; a win-win.