Borrowing from family and friends is one of the most effective and popular ways to borrow money in the UK and across the world. Whether it is for a new car, home, debts or new business, borrowing money from parents, siblings or grandparents plays a huge role in our economy.
In fact, some of the most successful businesses to date have started from a loan from parents or friends including Steve Jobs from Apple who got a loan from his parents and Mark Zuckerberg from Facebook who received seed capital from his college roommate Eduardo Saverin.
But when you are dealing with close relatives and friends and money comes into, it can get a bit tricky and very often leads to heartbreak and conflict. With this mind, Family Money gives you some of the top tips for borrowing successfully between friends and family. In this article we cover:
- Setting ground rules for borrowing money
- Having clear repayment terms in place
- Using parents or friends as a guarantor
- Whether you should use a formal agreement?
Setting some ground rules
When giving money to their children or friends, it is common for the person to ask what the money is for and some want to be anonymous. This can be an important aspect, because people want to know that their money is being used for the right reasons and it will enhance their quality of life or give them an opportunity – and not just a form of frivolous spending like shopping or luxury items.
Being clean and honest from the beginning is a good way to lend between friends and avoid any confusion down the line.
Some lenders like to put other ground rules in place like giving the money in stages and not in one full sum. Or some like to see the person earn their right to borrow money through showing a business plan beforehand and reaching a specific milestone in their business first.
Having clear repayment terms in place
When borrowing between family and friends, it is usually informal and for small sums, the idea is that you just repay their person on your next availability, which could be later today, tomorrow, next month or next year. In many cases, small amounts like £10 or £20 are just written off and forgotten.
Some of the most successful businesses to date have started from a loan from parents or friends.
For larger sums that run in the hundreds or thousands, it is sometimes important to put repayment terms in place such as the end of the month or year, when the person is likely to have access to more funds. In business terms, it is commonly suggested to repay a loan once they have made the money back and are profitable.
Questions on borrowing money from family and friends
A loan from a family member or friend can be an informal type of agreement, which is not generally declared. However, if it more formal as a financial agreement, then some form of profit will be generated from the agreed upon interest rates. Therefore, any income that is generated from this type of loan will count towards a lender’s earnings and they would have to declare this as a taxable source of income.
It is possible to make arrangements with a family member or a friend if they wish to take out a loan from you to proceed with a house purchase. This would commonly be considered a private mortgage or home loan, and certain terms would have to be agreed upon. This would include the interest rates and the duration of the mortgage, as would be the case with a loan from a formal financial institution.
While you may wish to help a family member or a friend at a time of need with a private loan, it is generally advised that you do not put yourself in the position of the go-to lender for them. It is commonplace that once a friend or family member reach a point when they need to borrow more money, they would come to the same person who lent them money in the first place. Therefore, it is important to set formal terms and agreements when borrowing and lending from family and friends.
Using parents or friends as a guarantor
If the parent or friend is reluctant to lend money, they can act as a guarantor for a loan from a main finance provider. This involves co-signing a loan agreement for a few hundred or thousand pounds and agreeing to repay the loan if the main borrower defaults.
It means that you are not actually giving up any money yourself, but you put your trust in them that they will repay on time – and you are happy to assist them. This option is better suited to those with bad credit histories since direct lenders for bad credit charge extremely high interest rates and should be avoided as much as possible.
If you have a good credit history, you may wish to apply for no guarantor loans, which is just between the borrower and another individual or party.
If you want to lend to absolute strangers and charge interest on your loans, there is peer to peer lending which is available for this exact thing.
Should you use a formal agreement?
The Money Advice Service talks about putting together a formal written agreement between all parties and having both parties sign the document. This is the closest thing to have a bank loan or with a financial provider. It then limits any possibility of the loan not being repaid on time and highlights other key points such as loan amount, repayment terms and penalties for late or no repayment.
If the parent or friend is reluctant to lend money, they can act as a guarantor for a loan from a main finance provider.
The agreement does not have to be witnessed by other people or be drawn up by a lawyer per se, as even this document can be very information and just created on Microsoft Word. In fact, some agreements for big ideas and large companies have been signed on nothing more than a cocktail napkin.