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

Naturally, some lenders are considerably more flexible than others and therefore willing to work with borrowers who have diverse and even less-than-favorable financial histories. Luckily, with enough time and careful planning, adequate steps can be taken before any big-time borrowing to drastically improve your chances of securing a low interest rate loan.

1. Know Your Credit

Do you have excellent credit, good credit, average credit, or bad credit? You should know before your lender does. If your credit is less than spotless – and if your need for a loan isn’t time sensitive – you can apply for a loan after taking necessary steps to repair your credit or possibly obtain a co-signer.

2. Correct Errors on Your Financial Record

Many people find that their credit histories contain errors that needlessly reflect poorly on their financial standing. Before requesting a loan, take the time to investigate your financial and credit records and correct any errors that could stand between you and the low interest rate you may deserve.

3. Research Reputable Lenders

Securing a low interest rate on a loan is important. But working with a reputable lender that can be trusted and honor commitments is far more important. Before doing business with any institution that offers a low rate, check to ensure that such claims are as legitimate as the lender.

4. Get Current and Stay Current

The more responsible your repayment history appears, the more favorably a potential lender will look upon you. If you have any outstanding late fees or unpaid penalties on a previous debt, settle up before you subject your financial history to the scrutiny it will come under during application screening.

5. Competitively Shop

One of the most effective mechanisms for getting a great rate on a loan is to competitively shop. Making banks and other financial firms negotiate for your business can be a great equalizer when other factors (your debt, credit, income, etc.) might be working against you.

6. Beware of Refinancing Penalties

The seemingly foolproof plan of taking out a loan at a high rate today in hopes of refinancing in the near future can ultimately prove to backfire. Many lenders attach substantial early exit fees if you seek to refinance within the first few years of the loan. The combination of a higher rate today with the penalties of tomorrow would effectively mute the benefits of refinancing your way to a lower interest rate.

7. Pay Down Debt Before Borrowing More

Reducing your overall debt before undertaking any additional borrowing is certain to help you get the lower interest rate you’re wanting. If possible, paying off another loan before requesting a new one will represent a responsible payment history and bode well for the next interest rate you receive from a lender.

8. Lock in Your Low Rate

If a lender’s standard variable rate is higher than other lenders (meaning you would pay more on the loan over time) consider a potential lender with a lower variable rate or, better yet, lock in a fixed rate until the loan is repaid in full.

9. Don’t Consolidate

You may think that having only one lump sum of debt will look better to a lender than several revolving accounts, but moving debt around in the form of a loan consolidation will look unfavorable on your financial history in the short term. Even if you have multiple credit balances (as long as they are not delinquent) keep them exactly where they are.

10. Borrow Less

This may seem like a no-brainer, but many individuals who seek a loan actually obtain more than they need. Naturally, by borrowing less you will not only reduce your overall debt burden, but you will be more inclined to secure a low interest rate since larger loans are typically those that carry the highest rates.

The Lowdown on Low Rates

Even the smallest decrease in the interest rate attached to a loan can mean the difference between saving or throwing away thousands of dollars over the life of a loan. Although cautious lenders will make you jump through many hoops to get the rate you’re looking for, any efforts taken to obtain the best rate possible will always pay off over the long haul.

Photo by j.c.westbrook