Borrowing money from family and friends: how to do it right
More of us are borrowing money from family and friends. But, whether you're a borrower or lender, you need to set some ground rules.
More than £2.6 billion was paid out in casual loans from friends, family and colleagues last year according to a report by O2 Money.
Almost half of adults lent money to someone but half of those are still waiting to be repaid.
If you've got the money, bailing out a friend or family seems the natural thing to do. Similarly, turning to family for help is normal, especially if alternatives like payday loans and maxed-out credit cards would make a bad situation worse. But mixing family and finance can easily turn sour.
If strings are attached to an IOU, all parties need to know that. Here’s how to lay foundations for a trouble-free lender-borrower relationship.
Who are you lending to / borrowing from?
It’s easy to love even the ficklest of friends when you’re not lending them money – but mixing the two could put paid to the friendship.
On the other hand, you might have a friend who needs some cash but who is also open, upfront and reliable. Needing a loan doesn’t automatically make them irresponsible or incapable of repaying.
Banks decide to lend or withhold credit depending on a number of criteria, including a person’s financial commitments and their history of borrowing. By contrast, you can base a decision on personality type (eg your friend always repays, even if the sum is 50p) and context, for example if a friend has a poor credit history because of previous mistakes they have since made up for, or because their finances were linked to that of an irresponsible partner or housemate.
However, if you’re the borrower, are you taking money from someone who is uptight and likely to put a strain on the relationship, or is the person relatively relaxed about money? Whichever role you are playing, both sides should agree the terms before money changes hands.
Lay down the ground rules
You could fix the terms of the loan from the start, in writing, with each party retaining a copy. It might sound unnecessary to begin with but it ensures there are no disagreements about who said what further down the line, which ultimately leads to resentment and bad blood between friends or relatives.
Decide how much will be repaid and when. The timeframe is important and you all need to be on the same page. You might be expecting the money back next month, while your friend is thinking that this is a loose agreement and they sincerely hope to pay you back one day, maybe in another lifetime.
Keep records of any repayments, so there are no quibbles about someone claiming to have repaid when they haven’t or demanding more when their money is already in the bank.
What happens if you lose your job and can’t pay back the money or, as a lender, if you need the money back? Could you freeze repayments until your friend finds work or as a borrower could you repay faster?
Depressing as it may sound, you should also plan for all eventualities, including death of either the lender or borrower. Agree on the steps you’re both happy to take if any unforeseen problems arise.
If the loan is a big one, and it’s a sum with the potential to rip a family apart or see you delete a friend from your contacts list permanently, you should seek professional advice. You could use the services of a solicitor or accountant to make an informal loan more formal.
LawDepot.co.uk provides a free draft promissory note, which sets out relevant loan details including the amount, the terms of repayment and any interest to be added on top. You can take this form to be checked over by a solicitor, who can act as a witness when you and the borrower sign.
Also beware that if you charge interest on a loan, this is additional income liable for tax and you would have to declare it to HMRC.
Other ways to borrow
Peer-to-peer lending lets you borrow and save without relying on banks or building societies. Lenders benefit from higher interest rates than traditional high street savings rates, while borrowers get decent rates and more flexible terms.
Beware that lenders have no guarantees for getting their money back if borrowers don’t pay up. The companies endeavour to reduce risk and credit check customers but if this happens you’re not covered under the Financial Services Compensation Scheme (FSCS) either.
Using a not-for-profit credit union can be another, more personal, way to borrow or save money. They are run as co-operatives – used and run by their customers. Money saved with credit unions is protected under the FSCS, for amounts up to £85,000 per person, per institution.
Despite alternative ways of borrowing becoming more popular, the traditional mainstream method is still worthy of consideration. Especially since personal loans have become so much cheaper in recent months. To find out more read Sainsbury’s Finance: top personal loan rates fall to 5.9%.
If you want to borrow from a lender on the high street or from a peer-to-peer lender, use our loans comparison tool to find a good deal.
Collect money from friends online. . .
If you’re only lending a small sum or if you’re organising a group event where multiple people will have to pay you back, you can try using Payumi to help avoid any nasty fall-outs.
This new website emails reminders to your friends about money owed and people can pay you back online with a debit card, credit card or PayPal. Read more at Payumi: new way to collect money from your friends online.