Lending and borrowing with friends and family is a touchy situation. As a lender, you want to help someone out without just throwing away your money or treating it like a gift. As a borrower, you are taking the money to get through a tough time, which likely means paying the money back won’t be particularly easy. However, if you treat the loan like an actual loan, not a casual exchange, you are in a better position to preserve the relationship while also getting out of debt in a reasonable amount of time. Follow these steps to protect your relationships while ensuring your debt doesn’t live on forever.
You need a formal contract
The first step in ensuring a positive borrowing experience is to set clear guidelines defining each party’s responsibilities. The lender has the easy job. They just have to write a check or hand over a pile of cash. As the borrower, the real responsibilities fall on you to follow through with your end of the bargain, paying back the loan.
To make sure both sides of the transaction are in agreement, a contract helps. A contract doesn’t show that you don’t trust each other. It just defines the agreement you made when borrowing money. Here are some important items to include:
- Loan amount
- Interest rate
- Loan term
- Date funds were lent
- Date of first payment
- Payment schedule
- What happens if you miss a payment
While contracts you sign with a bank when borrowing money are a bajillion pages long, a simple loan contract like this can fit on one sheet of paper. In fact, according to US law, it could even be written on a cocktail napkin. As long as it is written and both of you sign, it is a legal contract.
2. You need a method to track the loan
Unless you are borrowing the money for a fixed period of time and paying it back in one lump sum, you will make monthly or quarterly payments, or follow some other schedule, to pay off the loan.
Banks use something called amortization to calculate the payment schedule based on the interest rate, payment frequency, and amount borrowed. You can create a schedule like this using a spreadsheet program like Excel or through an online tool.
If you don’t know much about math and Excel, don’t worry. There are pre-made templates where all you have to do is type in a few key figures and pre-built formulas handle the rest.
3. Know that informal loans do not impact your credit score
Some people look to borrowing as a method to boost their credit score, but be aware that informal, person to person loans like this are not reported to the credit bureaus. Even if you make perfect, on-time payments every month, your credit score won’t budge when borrowing from someone else.
There is a platform that will allow for that which is currently under development. More on that in a few.
4. Understand this is a loan, not a gift
Borrowing from friends and family can cause serious relationship fallout if you don’t live up to your responsibilities and pay the loan back. If you treat the loan like a gift while the person you borrowed from treats it like a loan, you are on a collision course that won’t end well for your relationship.
There are countless reasons to avoid going into a borrowing relationship with a friend or relative. The worst horror stories do not come from the borrowers, however, they come from the lenders. Specifically, lenders who do not get paid back or do not get paid back on the same timeline as agreed. If you can’t comfortably stick to the schedule and pay back the loan on time, you should not borrow to begin with.
5. Use online tools to manage your loan
While you can use Excel to track your loan, a new, promising startup looks to make the entire experience of lending with family and friends easier and less risky. Money Mola helps you create a contract, does the amortization for you, and even offers automatic payments to make the entire borrowing experience automated and hassle free. The site has a roadmap which includes credit reporting and other useful features for both borrowers and lenders. Learn more at MoneyMola.com, which is launching soon to the public.
While Money Mola is working out the bugs, there are other options you can use for loan tracking and payments. You can use an online spreadsheet program like Google Sheets to make your loan payment schedule public to both of you, and use a free payment system like Dwolla or Venmo to move the money on payment days.
6. Make your finances a focus to get out of all debt for good
Ultimately, borrowing from friends or family can be a great decision for both parties. It can help the borrower get back on track financially or survive a rough patch while the lender may get interest in return, or just the warm, fuzzy feeling of helping someone they care about.
But as we already discussed, when a loan is not paid back as agreed, it can cause a major divide in the friendship. How would you feel if you lent someone money and they didn’t pay you back? Almost everyone has had this experience with $5 or $10 here or there, but when it comes to serious loans worth hundreds or thousands of dollars, nonpayment could lead to the end of the relationship for good.
Whenever you borrow money, go into it with that mindset. Know that if you pay the loan back, all is good. If you don’t make your scheduled payments, plan on watching that relationship struggle to continue, if it goes on at all.
As the borrower, the power is all in your hands. Go into the loan with the right attitude and make regular payments from the start. If you do, you will both come out on the right side of the loan with one more example of why you are a solid, trusted friend.