Using Friend & Family Loans

Sometimes when you need to borrow money your best option may be to borrow it from a friend or relative. Whether its $500 to pay for an emergency car repair, $5,000 for your business, or $50,000 to buy your first home, borrowing from people you know is not at all unusual and can be a smart move. After all, who else will agree to a low interest rate and a flexible repayment plan than someone who knows and trusts you? There is no need to be scared of mixing money and relationships as long as you do it carefully and mitigate the risks, as outlined below.

There are several occasions when the smartest financing step may be to use a friend or family loan. These are:
  • If it's your only option. If you have a poor credit history lenders may deem you too great a credit risk and either reject your application for a loan or put such a high rate on it that it makes it unaffordable.
  • If it's cheaper than other options. If your only other financing options are a high interest bank loan or your credit cards (which usually have rates in excess of 12-18%) borrowing from people willing to give you a lower rate is smart.
  • When it offers a great deal of flexibility. Since a private loan is a private deal between you and your lender, you get to pick the amount, the interest rate, the terms and the repayment schedule. As long as the lender agrees, during the life of the loan adjustments may be made to the payment schedule to accommodate changing circumstances and this can be a big help in keeping up with payments.
  • When people want to help. If your family and friends have the resources and trust you, and you can show them a good plan for making and repaying a private loan, there's a good chance the private loan can be a success.
However it is true that if you plan to mix money and relationships you should do so only with your eyes wide open. The two main risks of a private loan are first, that if the borrower fails to repay as agreed, the lender risks loss of the money. Second, if there are troubles with erratic payments or if the borrower ultimately fails the repay the loan, it's not at all surprising that the personal relationship may suffer. If you decide to borrow money from someone you know, there are several things you can do to mitigate these risks and get the loan off on the right foot.
  1. Treat the loan seriously. Handshakes are never enough. If you don't write down the terms in a promissory note, it is easy for misunderstandings or conflicting expectations to jeopardize the agreement and the relationship. Ultimately, the note protects the lender in case you default on the loan and the lender wants to enforce the agreement. Having a professional help you set up and formalize the agreement shows the lender that you are serious about repaying the loan and makes it a real obligation for you to repay.
  2. Use a fair interest rate. Don't assume that a friend or family lender will let you use their money for free; also don't assume that you have to pay what you'd pay the bank. You can probably agree to a rate which is a win-win for you both'higher than the lender might earn in a money market or a savings account, and lower than you would have to pay to get the money from a bank or financing company. However, especially if the lender is a relative, you must pay a minimum interest rate set by the IRS (it's called the Applicable Federal Rate and changes monthly) or the taxman may treat the loan as a gift.
  3. Pick a regular payment schedule. Pick a monthly or quarterly repayment plan which gives you the best chance of keeping up with your payments. Balloon payments or lump-sum payments at the end of the loan term are very risky for both borrower and lender. Borrowers inevitably cannot save enough to make the balloon payment and lenders inevitably cannot tolerate renegotiating the loan at the end of the term. The stress can be especially difficult when a relationship is at stake.
  4. Enjoy the flexibility. In a private mortgage you can pick your own loan terms when you set up the loan, and can make adjustments as you go. For example, you can set up your private loan with a deferment period at the beginning. If say, the loan is from your grandparents for education expenses, they may agree that repayment won't begin until a certain date after graduation, allowing you to defer payments until you are done with school and ready to begin a job. As long as your lender agrees you can also skip payments, move payments to the end or put the entire schedule on hold temporarily if circumstances come up that make it difficult to keep up.
  5. Use electronic debits to stay current. Find a loan servicing company that can do electronic servicing of your loan. In other words, can debit your bank account and credit your lender's account each month. Studies show that people who pay by check are 33% more likely to pay late. Plus it really makes the loan feel like business when there's a third party sending reminder notes and year-end reports.
CircleLending (www.circlelending.com) is a specialty loan servicing company that sets up and manages these types of private loans, and can report your payments back to PRBC to build your credit history.

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If you have a private loan or mortgage from a relative, friend or business associate, CircleLending can help you ensure that your history of payments is reflected in your PRBC credit report.