Borrowing money from people you know is a practice fraught with peril. However, it’s also one of the least expensive ways to get some cash when you need to solve a financial problem quickly.
Let’s take a look at some of the pros and cons of borrowing from relatives and friends.
Pro: Favorable Interest Rates
And, right about now you’re thinking, “Interest rates? I’m borrowing from people I know, why would interest even be involved?”
The short answer here is, it’s the classy thing to do.
You’re asking people to take money that could be working for them and put it to work for you. They have a right to at least make what they would have earned if that money stayed in their savings account. Besides, when you come to someone hat in hand, you’ll make a far better case for yourself if you offer compensation in exchange for the help.
With that said, the rate you’ll pay will be far less than if you’d taken the loan from a traditional lender.
Pro: Easy Qualifying/Greater Flexibility
Simply asking for the loan will usually be enough to secure it, unless you have an unfavorable financial reputation among your family and circle of friends.
If you run into an issue requiring you to delay repayment, the friend or family member is likely to be more forgiving of your request for additional time to pay or adjusted terms. This flexibility can be a considerable asset when you’re really in trouble.
Meanwhile, if you go to a bank or a credit union, you’ll be required to submit an application along with proof of your ability to repay the loan. You’ll also be subjected to a credit check, which can have a negative effect on your credit score. What’s more, lending institutions tend to be considerably less forgiving when you have trouble repaying.
Pro: Strengthened Relationship
If you borrow money from someone you know personally and repay it with interest, that person’s respect for you will grow. You’ve proven yourself to be a person of your word.
Should another situation arise, they would also be likely to help you again. After all, you’ve demonstrated you can handle the responsibility and respect the relationship.
Con: You Could Sour the Relationship
Holiday gatherings can get sketchy when you owe family members money and haven’t repaid it. Ditto on outings with friends. This will be particularly true if you’re indebted and show up in a new suit, a new car or with a new piece of expensive jewelry.
Worse, if it turns out you can’t repay the loan at all. This could ruin your relationship with that person forever. In some cases, you might be better off taking a debt consolidation loan to deal with your situation.
Con: Tax Concerns
Loans of a significant size can pique the interest of the IRS, triggering an audit of your benefactor. Insufficient loan documentation will open the involved parties to additional investigation.
Loans and gifts have tax implications. It is important to document everything carefully.
The main concern is making sure you stay within the guidelines established by the IRS governing lending between individuals. Follow the same procedures banks use when making loans. Craft an agreement you will both sign outlining the parameters of the loan and specifying a repayment plan.
Those are the primary pros and cons of borrowing from relatives and friends. While it can be a good way to solve a financial problem quickly, you also run the risk of doing damage to your personal relationships. Be absolutely certain you can repay the loan if you decide to go this route.