Many of us will turn to a loved one if we run into financial difficulty and need to borrow money.
Indeed, the Financial Lives Survey carried out by the Financial Conduct Authority (FCA) in October 2020 estimates that 5.9 million people borrowed from family or friends during the Covid-19 pandemic.
Whether you need money to tide you over until payday, to pay for an emergency expense, or to cover other costs, getting a loan from someone you know can be a quick and low-cost option.
However, borrowing money from family and friends may not always work. There is always the risk that something could go wrong and cause disagreements, which could sour your relationship.
As a result, it’s important to take precautions and consider different eventualities before agreeing to an informal loan with a friend or family member.
Find out some of the pros and cons of borrowing from friends or family, and what the borrower and lender should do before money changes hands.
What to consider before lending to friends or family
If a close friend or relative asks you for money, it can be hard to refuse. However, before agreeing to give them a loan, you should look at your own budget and ask yourself:
- Can you afford it? Or do you need the money for your everyday expenses?
- Would you be able to cope if the money was never repaid?
- Do you have an emergency fund in case your income drops in the future or you’re faced with an unexpected expense?
- What does the person need the loan for? Is it for a good reason or could lending them money do more harm than good?
- How likely is it that the borrower will repay the loan?
- Are you prepared for the effect a loan could have on your relationship with the borrower?
- Are there any tax implications? If you charge interest on your loan, you may need to declare this to HMRC as taxable income. Seek professional advice if you need more guidance on this.
Ultimately, you should only agree to lend money to a relative or friend if you are completely happy with the arrangement. Don’t feel guilty about refusing if you can’t afford to lend money or you’re not comfortable doing so. If you are pressured into it, then it’s unlikely to work out well financially or for your relationship.
How to borrow from friends or family
If you plan to borrow money from a friend or relative, there are some things you should do to try to avoid any problems from occurring. These points are particularly important if you want to borrow a large sum of money, but you should still consider them if you need a relatively small loan.
Work out your budget
Before asking for money, figure out exactly how much you want to borrow. Try to ask for the amount you need, so you don’t borrow more than necessary.
You should then look at your budget and work out how much you can realistically afford to repay at a time. This could make someone more willing to lend to you as you have given them some concrete numbers to look at, allowing them to judge how likely it is that you would repay the loan and how quickly.
Be careful who you ask for a loan
When you approach someone for money, make sure it’s someone you know and can trust. If someone you only met recently offers you a loan, you should be wary as they could be a loan shark who may expect you to pay high interest rates in the future.
If you ask a close friend or relative for a loan, don’t pressure or emotionally blackmail them into lending to you, as this would be unlikely to turn out well. Even if you did repay the loan in full, your relationship may have suffered. You may not know the full financial situation of an individual so if they are unwilling or reluctant to lend to you, it’s important to understand that they have their reasons and don’t force the issue.
Work out terms and repayment plan
If someone agrees to lend you money, you need to work out the terms of the agreement before any cash changes hands. Crucially, it needs to be clear whether the money is a gift that doesn’t need to be repaid, or if it’s a loan that does need repaying.
In addition to the basic repayment terms, you should also consider what would happen if you missed a payment for example. Even if you have every intention of repaying the loan, you never know what the future may bring and how it might change your ability to make repayments.
It’s important that both parties are happy with the terms of the arrangement. Some details to consider are:
- the size of the loan
- if the loan will come with interest charges or not
- the repayment schedule
- what happens if you struggle to repay the loan and miss one or more payments
- what happens if either party dies
Put the agreement in writing
Once you’ve both agreed to the terms, you should put the agreement in writing. This may seem unnecessary when you’re borrowing from someone you know, but a written agreement can help avoid any disputes and arguments over the money in the future.
A written loan agreement can offer some protection for both parties, as you can use it as evidence in case one person breaches the terms. For smaller loan amounts, a relatively informal written agreement signed by both parties may be sufficient.
However, especially for larger sums, you may want to draw up an official agreement with the help of a professional.
If you want to change the size of the repayments or make any other changes to the original loan agreement, make sure you update the changes in writing and don’t just rely on a verbal agreement.
Keep records of payments
Once you start repaying the loan, the lender should acknowledge the receipt of any payments in writing. Both parties should keep a record of the payments, so there can’t be any disputes over missed payments or the amount left to pay.
Pros and cons of borrowing from friends and family
Some of the advantages of borrowing from a friend or relative include:
- You can get a cheaper loan as most friends and family won’t charge much in interest. Many will offer a loan without any interest at all, so you would only repay the amount you borrowed.
- You don’t need to resort to an expensive form of credit, such as a payday loan.
- You may have more flexibility. For example, if you lose your job, are going to be late with a payment or want to pay off the loan early, your friend or family member is likely to be more accommodating than an official lender.
- You don’t need to pass a credit check to get a loan from family or friends. This could help you if you have a poor or limited credit history and can’t get a loan elsewhere.
Despite these benefits, there are a few potential disadvantages to borrowing from friends or family.
- It could affect your relationship if you miss a payment or have any other disputes over the loan agreement. At best, the loan could make things awkward between you, while at worst you could permanently damage your relationship with your friend or relative.
- You can’t build up or improve your credit history, unlike when you take out a formal loan or other type of credit. A good credit score could help you access a more competitive mortgage deal, loan, credit card and other types of credit in the future.
- If you’re the lender, there is a risk you won’t get your money back.
What to do if things go wrong
If you lend money to a friend or family member, there’s always a risk that they won’t pay you back. If this happens and you’re not prepared to write the money off as a gift, there are several actions you could take.
Firstly, you should try talking to the individual to see if you can come to some arrangement. This might be agreeing to smaller repayments or temporarily pausing repayments if the borrower is having financial difficulties.
If this doesn’t work, you may want to consider mediation. This is when both parties discuss the situation together with an impartial person present to help come up with a solution. You may need to pay for a professional mediator, or you may be offered free mediation if you submit a claim (below).
If the above has failed, as a last resort to get back the money you are owed, you could turn to legal measures. You may want to seek legal advice before starting any proceedings. A written loan agreement is likely to help your case if you want to claim back the money.
Bear in mind that you should never use intimidation, charge high interest, or resort to other illegal means to get your money back.
If borrowing from family or friends isn’t possible, there are other finance options you could consider and other more formal ways a loved one could help.
If a close friend or relative wants to help you but can’t lend you the money themselves, then they could act as a guarantor on a loan. A guarantor could help you to get a loan with a lower rate of interest as they promise to repay the loan if you miss any payments.
To be a guarantor, you will typically need to be over 21 years old, have a good credit score, have a stable income, and have a separate bank account to the borrower. You may also need to be a homeowner.
You can find personal loans from many different lenders, including high street banks, online providers, and credit unions. The best interest rates will go to people with the best credit scores, but there are still many options if your credit score is less than perfect.
If you’re a homeowner, you may want to consider a secured loan. You can typically borrow large sums with a secured loan, and get lower interest rates than on an unsecured loan. However, because this type of loan is secured against your property, if you don’t repay it, the lender could repossess your house to get back their money.
Some lenders may offer joint loans that you can apply for alongside another person.
Family members could give you a sum of money to help you get a deposit for a house.
Lenders will set certain rules surrounding gifted mortgage deposits and will want to check where the money is from. For example, lenders will want confirmation that it is a gift not a loan and that the donor won’t have any interest in the property. Check with the provider what their criteria are and what documents they would need.
A credit card allows you to buy something on credit and then have some flexibility in how you repay it. If you clear your credit card balance in full before interest charges start to apply, this can be a useful way to cover any short-term drops in your cash flow.
However, interest rates on credit cards can be quite high and debts can quickly mount up. So, if you don’t think you could repay it in full, it may not be the most suitable option for you.
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