Borrowing from family and friends is the most popular way to borrow money in the UK and indeed across the world. Where mortgage borrowing was £73.5 billion last year, borrowing between parents and children was around £88 billion for things including new homes, cars, debt consolidation and towards new businesses.
But when money comes between close relatives and friends, it can get ugly and can lead to conflict if not handled in the right way. We proudly offer some of the top tips for borrow successfully between friends and family
Understand what the money is for
Being transparent between all parties is very important and this starts with understanding what the money is for. The person who is lending the money typically wants to know what their investment is going towards and can feel betrayed if it is used improperly.
Essentially, they want to know that their money is being used for good such as paying off debts or helping the person get a start on life through their living situation or business. The last thing they want to hear is that their money is misused for recreational purposes, illegal activity or consumer spending.
Being clean and honest from the beginning is a good way to lend between friends and avoid any confusion down the line.
Putting repayment terms in place
When borrowing small amounts between family and friends such as £10 here and there, the money is rarely questioned and there is typically no need for interest or repayment. Many people just simply write it off or repay at their next availability.
However, for larger sums that run in the thousands, it can be worth putting repayment terms in place such as getting repaid in full by the end of the month, year or in monthly installments.
This adds a bit more formality to the transaction and manages expectations for all of those involved.
Do you charge interest?
Between close relatives and friends, it is not common to charge interest on an informal loan such as this. However, some social groups expect interest to be charged and this is likely to be determined between both parties. The rates charged should be more competitive than your local bank or if you went with a direct lender for bad credit, where you might be limited to higher rates.
Alternatively, some parents or friends may wish to take a percentage of sales or a stake in the business that they are investing in, preferring to take a long-term view than the immediate returns from a loans agreement.
Using parents or friends as a guarantor
If the parent or friend is unsure whether to lend money, they can act as a guarantor for a loan. This means co-signing a loan agreement and agreeing to repay any interest if the main borrower cannot keep up with payments. This can be a great way to give someone an opportunity, without having to put all the money upfront. However, there are risks, since the guarantor can be left with a huge sum to pay if it does not go to plan.
Should you write a formal loans agreement?
The Money Advice Service embraces the idea of putting together a formal loan agreement between family and friends. This can consist of just a few pages outlining the terms of the loan including rates charged, repayment expectation, amount borrower and late penalties if viable.
This does not need to be made by a lawyer, but can be put together on a word document and signed by both parties – for the very least to manage expectations.
Provided that you cover these areas, borrowing between family and friends can be very productive and effective. Some of our favourite restaurants and start-ups have thrived under this model including Facebook, Apple and Amazon!