Borrowing From Friends and Family: A Smart Move? Or a Big Mistake?

If you’ve found yourself in an uncomfortable financial situation – from a job loss, medical emergency, unexpected expenses, etc. – you might have considered asking family members or good friends for help. It sounds appealing, after all: someone who cares about you lending you money, likely with more flexibility when it comes to repayment than a traditional loan. But before you take that step, it’s worth spending a little bit of time considering the pros and cons of the decision and best practices if you go ahead with it.

Should You Borrow From Friends or Family?

There’s no cut-and-dried answer. It depends on you, your loved ones, and the situation you’re in. But there are a lot of reasons why it isn’t the best idea:

• You’re injecting business into a personal relationship. And that immediately complicates things. Whether it’s a parent, a sibling, a friend from high school, there are personal feelings involved that make it impossible to be impartial.

• Repayment could get awkward. If the loan isn’t enough or your circumstances don’t change or worsen in some way, how will you and your friend or family member handle that? What happens when they’re asking you to pay them back, and you can’t? Money matters can ruin a relationship quickly.

• It has no impact on your credit score. As pointed out by Wells Fargo, a family or friend loan isn’t reported to the credit bureaus, so you won’t get any of the boosts you might get from promptly repaying a formal lender.

• It can change the power dynamics in your relationship. Whether we like it or not, money changing hands affects things. Someone who lends money to you might then feel like they have some measure of leverage over you. They might use that to try to have a say in your decisions or to get something from you in the future.

Dos and Don'ts When Borrowing From Loved Ones

Pros and cons aside, according to the Consumer Financial Protection Bureau (CFPB), as many as one in five U.S. adults receive financial support from friends or family. If you do decide to go ahead with borrowing money from a friend or family member, there are a lot of tips and best practices that can help it from becoming an uncomfortable situation.

Get the details of your situation clear before asking for anything.

The CFPB recommends several questions that you should ask yourself and establish a clear answer before you approach anyone to borrow money. Things like:

•    What exactly am I asking for?
•    Do I have other ways to meet those needs?
•    How would my relationship to this person change if they agree – or if they turn me down?
•    Do I have the ability to pay this person back?

Discuss all the details of your loan with your loved one upfront.

The more everyone knows in this kind of situation, the better. The CFPB has a family lending worksheet to help guide this process, as well as suggested questions like:

•    Who is providing what (money, time, services, or something else) to whom?
•    How much, how often, and for how long?
•    Is this a one-time exchange, or happening on a regular basis?
•    How and when will the lender be repaid?
•    When will the arrangement be considered done?
•    When or how often will you check in with each other?

If possible, having a third-party present to witness the discussion and be a nonbiased perspective can be helpful in case you run into an issue where you and your family member need clarification.

Put everything regarding the agreement in writing.

When you work with a certified lender, you have paperwork that spells out all the details of the loan and your responsibilities. If you’re borrowing money from a friend or family member, you should treat it like you would any other loan and put all the details in writing. This keeps the situation clear for both of you, outlines everyone’s responsibilities, and should help avoid miscommunications. You don’t have to do this from scratch either.

Your promissory note should include details on payments, whether interest will be charged and how much, specifics on what happens if you can pay them back early, what happens in the event of default, and what state laws will govern the agreement.

Make a plan for if circumstances change.

We broke this one out because, while it should be part of the conversation before any agreements are signed, it’s worth putting extra emphasis on. None of us can predict what will happen tomorrow or next week or next month or next year. You can enter into a personal agreement with a family member or friend in good faith, only to be hit by a situation that makes paying them back difficult. Before you get into that situation, discuss how the two of you will address it in terms of notifying the person who lent money, outlining how it affects your current arrangement, and deciding how to go about finalizing a new one.

We All Need Help Sometimes

The only real constant in life is change, and we all find ourselves in situations where we need financial help. And while borrowing from a family member or friend can be an appealing option, it comes with a number of challenges that could damage your relationship. Sometimes, the better option is to work with a lender and keep business and personal matters separate.