If you don't have access to an affordable traditional loan, borrowing money from friends or family can be a viable option. When done right, family loans can benefit both parties. There's also plenty of opportunity for misunderstandings, strained relationships and uncomfortable situations, however. It's helpful to review the advantages and disadvantages of borrowing money from family and friends before you make a decision to go that route.
Advantage: Lower Interest Payments
If a bank isn't convinced you'll be able to pay back a loan, they'll charge higher interest rates to compensate for their risk. This means individuals with poor or limited credit history may only be able to borrow from a bank or credit union at exorbitant rates. A family member who knows and trusts you may be willing to offer you the same loan at a much lower interest rate. Pick an interest rate that's affordable but still gives your family member an incentive to lend the money.
Advantage: Interest Income
When you borrow money from a bank or credit union, your interest payment ensures the deal is profitable for the lender. If you borrow from family, those interest payments will benefit a loved one rather than an institution. If you have a family member who has a large cash reserve, he may be happy to earn a reasonable rate of return on his capital. Intra-family loans can offer investors better returns than they'd get on CDs and bonds.
Read More: How to Calculate Compound Interest Payments
Advantage: More Flexibility
Sometimes unexpected life events can make it difficult to meet monthly payments. With a traditional bank loan, you're hit with extra fees whenever you make a late payment, and it can be a hassle to renegotiate payment options. Some lenders even charge a fee if you want to pay off your loan early.
Family members can offer you more flexible options, says Intuit Quickbooks, and be more understanding of life events. A family member may extend a grace period, reduce your monthly minimum payment for a time or allow you to take a hardship deferment until you secure a new job or additional funding.
Disadvantage: Strained Relationships
If you're in dire circumstances, your family member may feel obligated to offer you a loan, but he might not be very comfortable with the situation. Even if he doesn't tell you so, he might resent the fact that you're tying up his cash or worry that he won't get it all back. This can make family events uncomfortable and cause a long-term strain on your relationship, warns SoFi. To avoid this problem, borrowers should be realistic about repayment schedules and keep family members in the loop about any potential delays in repayment.
Disadvantage: Changing Power Dynamic
Money changes a relationship. When you're in debt to a family member, he may feel he has the right or freedom to exert more control over your life. However, family members may criticize your lifestyle choices and spending habits or even ask to inspect your banking information. Making your payments on time and in full can help, but you may receive a guilt trip regardless.
Read More: Consequences of Borrowing Too Much Money
Disadvantage: Limited Legal Protection
When you work with a banking institution, it's obligated to provide you with the cash and terms outlined in your loan agreement. A family member might renege on the full loan amount or change the payment plan midway through the loan. To avoid confusion and misunderstandings, craft a promissory note loan agreement that outlines the terms of the loan, like the loan amount, interest rate and repayment schedule.
Based in San Diego, Calif., Madison Garcia is a writer specializing in business topics. Garcia received her Master of Science in accountancy from San Diego State University.