Borrowing from Friends and Family

When people find themselves in financial binds, it’s only natural to turn to close friends and family members for help. If you have earned their trust, your parents, siblings and friends may be willing to provide the cash that you need through a private loan. This can be a good solution, particularly if your lenders earn interest at a rate that is equal to or higher than what you would have paid to a conventional lending institution. If you care about your friends and relatives and want to keep the door open for future business dealings, make sure you create a situation in which everybody wins.

In some ways, private loans are easier to obtain than traditional loans. After all, you don’t have to have a high credit score, a steady income or even a solid cash reserve. All you have to do is convince someone you know that you are a good credit risk. This doesn’t mean you have a license to take advantage of the lender, however. Do not enter into any agreement unless you are fully capable of living up to your end of the deal.

Choose your private lender carefully. Consider whether the person’s financial security may be jeopardized. An uncle or grandparent who has little spare cash or who truly cannot afford to make the loan is a poor choice. Your family may never forgive you if your loan forces another relative into bankruptcy or otherwise causes hardship.

To maintain good relationships, choose a lender who sees the value of making the loan and will not attempt to call in the debt early. It is best to put everything in writing so that all participants know exactly what to expect and everyone feels protected. Early in the process, find an attorney who has the trust of both you and your lender to help you with documentation. It’s also helpful to consult a tax adviser.

Documenting your loan will prevent misunderstandings about whether the money was a loan or an outright gift. An important document will be the promissory note. This is an acknowledgment of debt with a promise to repay in an agreed-upon manner. A binding contract, the note will include the interest rate and a payment schedule.

You also will need a mortgage or deed of trust, which provides collateral for the promissory note. This document states that your lender can take over the property if you don’t repay the loan along with agreed upon fees and interest. It requires the borrower to pay principal, interest, taxes, and insurance on time, maintain hazard insurance on the property, and keep the house in good repair.

As you shop for a lender among friends and family members, prepare yourself for rejection. It may surprise you to learn that the aunt who baked you cookies when you were young doesn’t trust you to repay a home loan, but try not to take it personally. Remember, it’s her money and she has the right to decide how to spend it. If someone is reluctant to loan you money, pressuring them into it will only lead to trouble later on. If you keep a positive and accepting attitude, you will be able to discuss your need for a loan -- and your ability to repay it -- without injuring feelings or creating rifts.