Borrowing and lending money to Friends and Family can be a fast and affordable way of accessing money when you need it the most. But like any other credit product, it comes with a set of precautions.
So, why do we believe friend and family lending is an untapped source of finance? And how can we avoid the risks associated with it? Let’s look at friend and family lending and explore the pros and cons.
When it works, a friend or family loan is a great way to get affordable finance without going through the banks, whether to tide you over till payday or help you secure something more substantial like a wedding or a down payment on a house. And it’s not uncommon, with
- Six million people in the UK borrowed from friends & family in the pandemic alone.
- 56% of first-time buyers finance part of their deposits from family members.
- 19% of 18 - 24-year-olds had borrowed money from friends or family, compared with 10% borrowing via a credit card and 9% a personal loan
It’s an excellent alternative to a traditional credit product, an affordable, flexible source of finance that can give you a lifeline when faced with emergency costs. It also skips the need to fill in forms or go through credit checks credit. So, why is there still so much stigma around it?
We’ve found that the most significant barrier to friend and family loans is the awkwardness that attaches itself to the topic of finance. When experiencing financial worries, 55% of people in the UK don’t feel comfortable talking about money. Personal finance isn’t a topic readily discussed, and letting people around you know that you may be struggling for cash or facing debt can be a challenging conversation to broach. This lack of openness around the subject of money leads so many of us to follow the old rule: Don’t mix love and money.
Obviously, people don’t want to damage their relationships with their loved ones. That’s a no-brainer. But is our inability to talk about money and finances holding us back from a huge source of untapped financing?
There are indeed situations where loans between friends and family members can have a knock-on effect on the relationships themselves, which puts some people off this source of finance, But “No one talks about the loans that go well,” as Sara Williams (writer at the Debt Camel blog says) "The dad that pays off your payday loans and gets you out of a debt spiral; the sister that lends you the money for a tenancy deposit. People are often very motivated and determined to repay these loans.”
So, let’s take a deeper dive into the pros and cons and explore how you can borrow and lend money to people you know, the Punk Money way.
Why borrow from Friends or Family instead of taking out other forms of credit?
Affordability. With the average cost of credit card interest around 20%, overdrafts nearer 40%, and short-term loans much higher than this, borrowing money from friends and family can often be a much more affordable route of finance with lower interest rates or none at all.
Ease. There are no forms to fill in or long credit check processes, which leads to a faster route to accessing the finance you need. It also allows people with bad or limited credit history to attain affordable rates.
Flexibility. Traditional loans and credit products have strict payback terms, whereas you can negotiate more flexible terms with people you know.
Understanding. Friends and family are more likely to be understanding if there are difficulties making repayments, whereas commercial lenders may threaten legal action if payments fall behind schedule.
What are the risks?
As with all forms of investing and borrowing, loan agreements between friends and family come with risks.
Not getting paid back
This is one of the top concerns lenders have. Missing payments or not living up to your end of the agreement can strain your relationship with the person you’re borrowing or lending to.
The strain on relationships
While this is especially the case if payments are missed, even without breaking the agreement, just the act of loaning someone money can subtly change your relationship dynamic. It’s something both the lender and the borrower should check in to make sure they’re comfortable with it. If not, it doesn’t need to be the end of the discussion. There are ways to reintroduce more balance by, for example, agreeing to pay back the loan with interest decided by both parties. More on this later.
Finance may be limited, and the lender might need the cash
What happens if the lender suddenly faces unexpected financial circumstances during the loan term? Could this lead to a dispute or them asking for the loaned money back? People you know simply may not have the amount of cash that covers what you need.
Lots of people find broaching the subject of borrowing money awkward. It’s understandable. But it doesn’t have to be.
Brad Klontz (financial psychologist and associate professor at Creighton University in Nebraska, US) says, “Experts agree that if you go into the situation without a clear repayment plan, it’s likely to backfire: “It’s a recipe for resentment,” says Klontz. Many of the risks above are easy to avoid, but you need to put the work in. If you’re going to make the step to enter into a financial agreement with a friend, you need to communicate and plan effectively to prevent problems from arising in the future.
Keeping it between friends; How to do it right
Lending money to people you care about is affordable and flexible and feels great. But the stigma around asking friends and family for help and the hassle involved with social loans often puts people off these types of agreements or makes people regret their choices. With 50% of people regretting their choice after (source). Often deferring back to financial lenders the next time they need some cash.
Work out your budget
Before broaching the subject with a friend or family member, work out exactly how much you need to borrow. Then look at how much you can afford to repay at a time, considering future income and expenses. Be honest and put together a reasonable plan. Just like a normal loan, be realistic and have a clear goal of how you’ll make repayments.
At this stage, it’s always best to write some notes down and work out the exact calculations. This will give confidence to the person you’re asking for a loan from, and you can display concrete evidence that you can afford to repay the loan.
Work out terms and repayments
Before any money changes hands, you should agree on a repayment plan. It’s critical to establish whether the money you’re asking to borrow is a gift or a loan. A gift will not require repayments, whereas a loan requires you to make repayments. Both gifts and loans may face some tax implications.
Checklist to consider
- What’s the size of the loan?
- Is interest being charged or not?
- Set a repayment schedule
- What happens if you struggle to repay the loan and miss one or more repayments?
Put it in writing
Once you’ve come up with the pillars of the agreement, creating a loan agreement template or contract is a wise move. This way, both parties understand exactly what is expected of them. Once the agreement has been drafted and everyone’s happy with the terms, it’s time to sign on the dotted line. It doesn’t mean you can’t make changes to the terms in the future, but if any changes are made to the original contract, make sure to update the loan agreement. And always keep a record of the payments.
Live up to the terms
Once the loan is agreed to, stick to the terms you made. Make your repayments on time by setting reminders and keeping to your budget. Don’t let the loan interfere with your relationships.
The team at Punk Money has put together a comprehensive guide to borrowing money from friends and family that gives tips on broaching the conversation and the best steps to follow.
The Punk Money way.
We’ve fine-tuned friend and family financing to remove the hassle. Our app is designed to make loans that are simple, clear, and fair; friendly but formal. There are so many different reasons people loan money to the people closest to them. Still, more often than not, people feel too uncomfortable to broach the topic or feel there are too many difficult conversations to have before they decide.
It takes less than five minutes to build a loan agreement with Punk Money, which creates a legally binding contract, a structured plan, and the ability to add interest on top of the amount being borrowed.
Share the loan proposal straight through your phone book, and your friend or family member can easily view the loan agreement.
Never miss a beat with automatic repayments and reminders, so no awkward conversations need to happen, and you can focus on the things that matter.
Track your loans in the app and see a full record of payments, so there’s no need to dig through bank records or keep any excel sheets to manage your finances.
Build your credit score by borrowing between friends and family
One of the main downsides of borrowing money from friends and family in the past was that repayments do not help build your credit score.
But with Punk Money, we report payments to the credit bureau. For the first time, loans between family and friends will help build your score.
We’re hoping to make friends and family lending the norm by breaking down the barriers along the way. What will this cost you? Nothing. Our platform is free to use for both borrowers and lenders.
If we can get over the uneasiness and rethink how we approach the topic of finances, borrowing and lending money within our social circle and community is simply the better financial choice.
Reach your financial goals with affordable finance from the people you care about.