When seeking investment for a business or facing difficult financial times, it may be tempting to turn to friends or family for help. Though it can be one of the easiest ways to acquire a quick loan, borrowers should be wary of the potential downsides.
Assess your relationship
Friend to friend, parent to child, child to parent, brother to sisterborrowing money from someone makes you beholden to that person, says Karen Haywood Queen, contributor to Bankrate.com.
She warns that when you borrow money, the power dynamic of the relationship may change. The lender may feel entitled to inspect your checkbook or to make lifestyle judgments, especially if they are a family member. Borrowing money can put unforeseen stress on your relationship with relatives; and with friends, the entire relationship itself may be put in jeopardy.
Involving friends in your money woes is a major risk, explains Brianna McGurran, a staff writer for NerdWallet.com, in a July 2017 article. They dont have to love you unconditionally, and you might lose their respect if you dont pay them back.
Before borrowing money from family or friends, ensure your relationship is robust enough to survive potential disagreements about finances and lifestyle that would not occur when borrowing from a financial institution.
On the upside, successfully borrowing and repaying money from a relative or friend can strengthen the relationship, as both parties may come out with renewed respect and trust for each other.
Treat it only as a last resort
Before you ask for a loan, ensure you have taken all other steps toward improving your financial situation. This includes calling your credit card companies to negotiate better interest rates, asking for a raise at your job, tracking your spending to identify where you can save money, starting a budget and exploring other options for earning money.
According to BusinessInsider.com, this is because you wont be ready to take the responsibility of a loan from a relative or friend without first having taken these steps. If you were to ask for a loan from a bank, they would want to make sure you are prepared to handle the funds properly. A friend or family member is more likely to be affected by guilt and the desire to help, so the responsibility falls on the borrower to establish good habits in advance of borrowing, and exploring borrowing as a last option to bridge a small financial gap.
Get it in writing
Whether you are lending or borrowing, and whether the loan is big or small, it is highly advisable to make a written loan agreement even when family and friends are involved. The more the transaction is treated in a professional and business-like manner, the better.
A written loan agreement can make both parties more comfortable with the whole arrangementespecially if youre borrowing a significant amount, writes Catherine Fredman, a personal finance adviser, in a 2015 article for Consumer Reports. A formal contract shows that you respect the lender and understand that repayment is required. Furthermore, if you should die, the lender will have proof to get the money back from your estate.
At the end of the day, obtaining a loan from a family member or a friend can be risky and may end up affecting your relationship more than your personal finances. That is why, if possible, it is ultimately preferable to secure a loan with your financial institution.