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Borrowing Money from Friends and Family

System - Thursday, September 19, 2013

Borrowing from friends and family

Everyone warns against lending money amongst family and friends, but sometimes it's the only recourse. Here's what to expect, and how to make a loan go smoothly.

It can be unnerving when an unexpected event turns into a major expense, especially when you don't have the means to pay for it.

Beth and her husband were still in college when the engine blew in their 5-year-old car. Their dilemma: Pay $5,000 to repair the otherwise OK car with a remanufactured engine, or spend even more money to buy another car. Either way, they had no cash and no credit. And they had a paltry emergency fund.

Sometimes the easiest solution seems to be calling on family or friends for a loan. But proceed with caution. We interview borrowers from two families who requested anonymity. Their stories reveal when borrowing money works, when it doesn't and what you can do to make sure your loan goes smoothly.

Beware of power shifts in the relationship

Friend to friend, parent to child, child to parent, brother to sister -- borrowing money from someone makes you beholden to that person.

"When you borrow money, it changes the power dynamic," says personal finance expert Manisha Thakor, CFA. "That's the overarching umbrella."

That's one reason Beth and her husband did not borrow more than once from her in-laws. "There were other family members who were habitual borrowers," she says. "My mother-in-law felt like she had the right to inspect their checkbooks."

She also made lifestyle judgments, Beth says. "My husband's brother was a frequent borrower. (My mother-in-law) felt she had the right to say, 'You need to quit smoking' or 'I'm not going to give you money unless you quit drinking soda.' You can use money to manipulate people, and I don't think that's right."

Be business-like in your dealings

Beth and her husband approached the car loan as a business deal. Before going to her father-in-law, the pair listed the pros and cons of buying a new car or fixing the car they had. They decided repairing their current car made the most financial sense.

They outlined their proposition to Beth's father-in-law and checked to make sure he agreed with their assessment. Then they asked him to lend them the money, which they'd pay back in monthly installments.

"We went to the Bank of Dad and said, 'We'd rather borrow the $5,000 from you,'" Beth recalls. "It was a no-interest loan. That was huge for him."

This could have been the story of how to borrow money and make it work. But Beth and her husband found that even doing everything right doesn't guarantee success.

Have a back-up plan

"We took the car to the mechanic to get the work done," Beth says. "After the work was done, my father-in-law said, 'I've been thinking about this. I don't want to loan you the entire $5,000. I'll loan you $3,500 and you have to come up with the rest on your own.' He said it was his money, his decision, and he could give us no (extra) money."

Faced with the mechanic's bill, Beth and her husband were really in a jam. So they cleaned out their savings account, which they had hoped to reserve for any other unplanned expenses.

The relationship may suffer

Beth and her husband continued to be civil and make appearances at family holiday gatherings, but they curtailed their other visits and family activities.

"If he'd said that from the beginning, we would have been fine," Beth says. "But we were very angry that he changed his mind after the fact. It was the principle. We had approached him as a business arrangement. That's why we were so angry."

It took about two years to get back on good terms.

Beth took a weekend job selling women's shoes for a year. "That's enough to make you angry," she quips. The couple paid the money back in 18 months.

In most cases, that's the best way to keep the relationship on good terms, Thakor says.

"Make timely payments -- every single time," she says. "I've observed that when people are getting paid back on time, the power dynamic tends to stay in balance as each party is doing what the other expected."

Get it in writing

Some families treat a loan as a business transaction. Ann has borrowed money three times from her parents -- and it went well each time. Fresh out of college with no credit history, she borrowed $2,000 to buy her first car.

She paid $100 a month and had the loan paid in full within two years. Later, Ann borrowed $10,000 to help with the down payment for her first home. She took three years to repay that loan.

Each time, Ann had a written agreement. "My father majored in accounting, and he thinks that way," Ann says. "Dad explained that if someone died, the lender would have proof against the estate to get the money back. It's helpful to have everything in writing, even if you know everybody has the best intentions in the world."

Build a credit history

Ann had established herself as a good credit risk at the Bank of Dad. Good thing, because her third loan, a short-term bailout, was needed to keep her second home purchase on track. Less than 48 hours before she was due to close on the home, a mortgage officer realized that Ann's pending purchase counted as a second home.

She was buying the home to prepare for an eventual move to be close to family, but planned to remain in her current home at least a year first. The bank required 30 percent down instead of only 20 percent.

"I had the assets," Ann says. "I just did not have anything I could write a certified check on. The sale would not have been able to take place. It would have been a mess."

With her track record, her parents didn't hesitate to lend her $17,000. One sentence sealed the deal. "I am borrowing this money, and will pay it back." And she did, within two weeks.

When her parents found themselves in the same situation -- equity-rich but cash-poor -- Ann didn't think twice about lending them $35,000. It was a chance to reciprocate and come to her parents' aid for a change.


By: Karen Haywood Queen


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