Borrowing from friends and family: Your 6-step guide

They should be your last resort, but these tips can help make it work for both of you

Borrowing from friends, family: Your 6-step guide

Call it the bank of last resort.

Hitting up your nearest and dearest for money is never ideal. Or even a first option. But if you’re in a bind, there are ways to make it more palatable – for both of you.

The Golden Rule of borrowing from someone close to you? Treat the situation as if you were talking to a bank:

  • Full transparency.
  • Documentation.
  • Agreement in writing.
  • And, it should go without saying, pay it back.

If you’re considering borrowing from a family member or friend, here are six things you should know:

BORROWING FROM FRIENDS, FAMILY
AT A GLANCE
  • Keep it professional. Treat the situation as if you were talking to a bank.
  • Explain why you need money. Help them assess the risk and understand how you’ll use the money.
  • List the other options you tried before asking them for money. Admitting they are your last option will bolster your case.
  • Compensate for the lost use of the money. Make this a good deal for everyone.
  • Draw up a promissory note. Protect both of you by putting the details in writing from the beginning.
  • Be realistic. Analyze your finances to determine how much you can afford to repay and when.
BORROWING FROM FRIENDS, FAMILY AT A GLANCE
  • Keep it professional. Treat the situation as if you were talking to a bank.
  • Explain why you need money. Help them assess the risk and understand how you’ll use the money.
  • List the other options you tried before asking them for money. Admitting they are your last option will bolster your case.
  • Compensate for the lost use of the money. Make this a good deal for everyone.
  • Draw up a promissory note. Protect both of you by putting the details in writing from the beginning.
  • Be realistic. Analyze your finances to determine how much you can afford to repay and when.

1. Keep it professional.
Mixing money and family is always a dangerous cocktail. But if you keep it professional, you increase the chances of preserving both the relationship and your financial well-being. And you’ll still have a place to eat Thanksgiving dinner.

That means treating this situation like you were going to a bank, says Jill Gianola, owner of Ohio-based Gianola Financial Planning and author of “The Young Couple’s Guide to Growing Rich Together.”

When you propose the loan, tell them, “I only want to go forward if this makes sense to you,” she says.

Don’t be afraid to produce paperwork. Keep the conversation light and businesslike.

  • If the answer is no, accept that gracefully.
  • If the answer is yes, put the agreement in writing.

And remember, you’d never ask a banker for “an advance on your inheritance,” says Gianola.

“Don’t be afraid to produce paperwork. Keep the conversation light and businesslike.”

There is, however, one exception to “treat it like a bank:” Don’t negotiate, says Andy Byron, senior financial adviser and principal with California-based HC Financial Advisors.

You ask, and their first answer is the answer. Your dad may be able to loan you only $1,000, instead of the $3,000 you wanted. Or your best friend may need the money back within six months, instead of a year. Unlike a bank, you’re asking this person to do something they don’t do every day. And they’re already emotionally invested in you.

So, don’t haggle.

2. Explain exactly why you need the money.
The reason matters to the lender, says Byron, who’s been on both sides of the equation – borrowing money for a down payment when he and his wife were just starting out, and paying it forward to family members decades later.

The “why” of the loan helps them assess the risk, he says.

Are you buying a house? Starting a business? Behind on some bills? Your lender deserves to know how you’ll be using the money.

If the loan is for your business, come to the meeting fully prepared. Just like you were courting any other investor, says Byron. “Show them a business plan.”

  • You want to be able to show them what your enterprise does, what it earns and what it consumes.
  • What are your profits and losses? What are your business projections?
  • And are these numbers you’ve inserted into a spreadsheet, or do you have (as a bank would require), actual documentation to back up your estimates?

Enthusiasm is great. But you need more than your own confidence that goldfish dung will become the next bitcoin, or you’re not getting that loan.

3. List the other options that you tried before asking family or friends for money.
Chances are, you tried to solve your financial shortfall in myriad ways before turning to your inner circle for money. Admit that, says Byron. It bolsters your case (and your credibility) if they know you’re not turning to them because it’s easy – but because you’ve explored all other options and come up dry.

Also, be prepared to tell them why those other efforts were not successful, he says.

  • You might have great credit, but your credit history is too short to get a loan. (But that good credit is a point in your favor.)
  • Or, you have a pile of medical expenses, but you’ve been able to negotiate a much lower bill with the doctors and the hospitals. (Which shows you’re actively managing your financial affairs, not passively waiting for someone to save you.)

By demonstrating what you’ve already done to cover your shortfall, you show the lender that you truly have done everything possible before even considering asking for a loan.

And make sure this is a one-time request. You don’t get to use a friend or relative as an ATM, Gianola says.

“Make sure this is a one-time request. You don’t get to use a friend or relative as an ATM.”

4. Compensate for the lost use of the money.
Hopefully, your lender isn’t selling stocks or valuables to make the loan. (If they are, you really need another lender.)

“If you’re asking someone who has to go to these extremes, you can’t create a win-win,” says Jonathan Fox, professor of financial counseling and planning, and director of Iowa State University’s Financial Counseling Clinic. “If they don’t have cash reserves, you take ‘no’ for an answer and move on.”

  • If the lender does have ready cash sitting in an account, it’s likely earning some interest.
  • Make this a good deal for everyone by offering an interest rate over and above what the lender is already getting. (More on why you need to pay interest here.)

“You build in a rate of interest and make it contractual,” says Fox.

5. Draw up a promissory note.
Anyone who’s ever watched “Judge Judy” knows that a loan without paperwork is a gift in the eyes of the law. If your friend or family member agrees to become your temporary banker, protect both of you by putting the details in writing.

Points to include:

  • How much is the loan?
  • What is the interest rate?
  • On what dates are payments due and how much are they?
  • How will those payments be made: PayPal, Venmo, check, automatic debit?
  • What is the grace period for payments, and how much is the penalty if you’re late?

“It would make a lender feel more confident if the borrower was serious about it with a schedule, with a plan,” says Frank Moore, founder and chief investment officer for Michigan-based Vintage Financial Services and past-chairman of the board of the National Association of Personal Financial Advisors.

You can find free templates for loan agreements all over the web, but we even make it easier for you: Consider CreditCards.com’s sample promissory note for loans to family, friends.

“Having a repayment plan and contract eliminates stress for both parties.”

Having a repayment plan and contract eliminates stress for both parties, says Fox, who admits that he’s been on both sides of the transaction. But “when it’s clear that there’s a mechanism for repayment, I’m comfortable,” he says.

There are also services that will act as financial middlemen, sending bills to you and forwarding the payments to your lender. But middlmen have to get paid, too.

So, unless you or your lender absolutely needs to keep an arm’s length distance in the transaction, you can put that money toward building your emergency fund or repaying your loan.

6. Be realistic.
Before you ask anyone for anything, analyze your finances. Based on what’s coming in and going out:

  • How much can you afford to repay and when?
  • While you’re making those repayments, are you also putting money into an emergency fund so the same situation doesn’t recur?

If the lender knows you not only have a schedule for repayment, but an emergency fund to make sure the shortfall doesn’t recur, the reaction is more likely to be, “Wow, this person has built in some contingencies here,” says Byron.

And, if not, you may want to ask for a longer repayment term.

If you need help, you can engage a free or low-cost certified financial counselor through the National Foundation for Credit Counseling.

Taking an honest, in-depth look at your finances also means that you can answer any questions your prospective lender may have, and shows them that you take this seriously. There’s a benefit to going through the borrowing process, says Byron. “It forces you to look at things.”

Plus, both of you will know that those answers are backed with facts – not just your desire to repay the loan as quickly as possible.

See related: Lending to friends and family: Your 4-step guideHiring a debt collector to enforce loan to friend, family


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Updated: 11-22-2017