Cash 1 Blog
Friendly Loans: Everything You Should Know
What Is a Friendly Loan?
A friendly loan is when someone lends money to a friend without official paperwork or a contract. The loan excludes banks or credit unions, and borrowers typically do not schedule payments.
These loans revolve around trust and goodwill as a close tie between both parties enables the successful exchange of money. The borrower needs to clearly understand the expected due date, terms, and conditions to avoid any future misunderstandings.
How Common Are These Loans?
Friendly loans are typical in the United States. Research conducted by the Consumer Financial Protection Bureau in 2021 showed that up to one-fifth of American adults are recipients of financial aid from their friends or family. Additionally, up to one-third of American adults assist others. It can result in more money in the borrower's pocket, but it can also put them in a difficult position.
Loans between family members and friends are a convenient way to help each other. These financial agreements don't have to be limited to parents and their adult children; they can exist between two people, even roommates or siblings.
People may rely on their family and friends for emergency loans in certain situations. These loans could also result from needing other options for obtaining money. Loans from friends can also finance monthly expenses, pay tuition, or purchase a home in the short term.
Advantages & Disadvantages of a Friendly Cash Loan
Some advantages to borrowing from a relative or friend include the following:
- Because friendly loans are often informal, they have significant advantages over loans from traditional lenders. You can receive loan funds quickly through cash, check, or a financial app.
- You can get a cheaper loan from friends and family, as most won't charge much interest. Many will even offer a loan without interest, so you only have to repay the borrowed amount.
- You may have more flexibility if you borrow from a friend or family member. They will likely be more accommodating if complications occur than a traditional lender.
- If you have a low credit score and need money, borrowing from family or friends can help you. Unlike banks or other lenders, you don't need to pass any credit check when getting money from them.
Despite these benefits, borrowing from friends or family has a few potential disadvantages.
- Missing a payment or having other disputes over the friendly loan agreement format could affect your relationship. At best, the loan may make things awkward between you. At worst, it could permanently damage your relationship with your friend or relative.
- Feeling guilty and ashamed for not repaying a loan can be more robust when borrowing from non-traditional lenders. This feeling compares to defaulting on a loan from a traditional lender.
- You can only build or improve your credit history by taking out a traditional loan or other types of credit. Having excellent credit could help you access a more competitive mortgage, loan, credit card, or a different kind of credit in the future.
- If you are the lender, there is a risk that you will not get your money back.
Types of Friendly Loans
While these types of loans are popular, the process may need to be more well-known. There are different types of loan agreements between friends available.
A friendly loan can be an unsecured loan that does not require collateral. It involves an agreement between the borrower and lender, who are often familiar with one another. Both parties verbally agree upon the repayment term.
A friend or family loan can be secured, meaning the borrower agrees to use an asset as collateral. If the borrower defaults on the loan and cannot repay it, they must surrender their asset to the lender.
Loans With a Promissory Note
A promissory note is a written agreement between two parties involved in a friendly loan. It serves as an IOU or promise to repay the borrowed money. A promissory note is not legally binding like a contract. Still, it can provide better protection for both parties involved.
What to Consider Before Taking a Loan?
Before asking a friend or family member for a loan, one should consider the following questions:
- Will this loan affect our relationship? Mixing family ties and finances can be touchy. Think carefully about whether this loan could irreparably damage your relationship.
- What will my friend or family member expect from me? Your friend or family member may expect you to take on more obligations around the home if they provide a loan. Examples of these obligations include helping with chores and other tasks.
- What other options do I have? You should carefully weigh the pros and cons of asking a friend or family member for a loan. Also, consider other options to help with your financial situation.
- What does success look like for this loan? You and your friend or family must have a favorable view of the arrangement to achieve success. You must take the necessary steps to ensure that both meet all conditions for a successful outcome.
How to Build a Friendly Loan Agreement?
The lender and recipient should create a loan agreement or promissory note for the best chance of a positive experience. These documents help treat the loan seriously and ensure all parties know their obligations.
The loan details include the loan amount, its use, and when and how repayment will occur.
A frank conversation about expectations should occur once one friend or family member gives a loan to another. Both parties must be on the same page to ensure the arrangement works well for everyone involved.
A discussion should cover questions that include:
- When will the financial arrangement be reviewed?
- Is this a one-time loan, or will you ask for more support?
- What happens if you need help paying the money back as planned?While this conversation is a good starting point to ensure you meet expectations, further details and expectations may require legal measures.
What to Do if Things Go Wrong
If lending money to a friend or family member doesn't go as planned, don't fret! There are a few measures you can take.
- Discuss openly with the person who borrowed money to develop a fair solution that benefits both parties. This could involve reducing payments or temporarily waiving them.
- Mediation is the next step. When making claims, get a neutral third party, like a mediator (paid) or free dispute settlement provider.
- If all communication attempts prove unsuccessful, look into legal action after seeking guidance from your lawyer. Having documentation like written loan agreements may help your case significantly.
It is important to remember not to use intimidation or charge high interest when trying to get money back. Illegal means should never be resorted to recover one's money.
Suppose borrowing from family or friends is not possible. In that case, there are other financial options to consider and different, more formal ways in which a loved one can assist.
Personal loans are available from many lenders, including banks, online providers, and credit unions. People with the best credit scores will get the best interest rates. However, many options are still available for those with lower credit scores.
Homeowners should consider a secured loan to borrow large sums quickly and with lower interest rates than an unsecured loan. However, this type of loan is secured against the property, meaning the lender could repossess it if the repayment schedule is not followed.
If a relative or friend cannot lend you the money, they could act as a guarantor on the loan. A guarantor could help you get a loan with a lower interest rate. They promise to repay the loan if the borrower misses any payments.
To be a guarantor, you need a good credit score, be over 21 years old, have a stable income, and have a separate bank account for the borrower. Additionally, you may need to be a homeowner.
A credit card allows you to purchase items on credit and pay them back in installments. If you pay the balance before interest charges are applied, you can use it to cover short-term cash flow issues.
However, the interest rates on credit cards can be high. Debts can accumulate quickly if not managed properly. Remember that you should only use a credit card if you are sure of being able to repay the debt in full.
Family members can provide financial assistance to help secure a deposit for a house. Lenders have specific rules regarding gifted mortgage deposits and need to confirm the source of funds. Lenders will want confirmation that the money is a gift, not a loan, and that the donor has no interest in the property. Borrowers should check with their lender what criteria they must meet and which documents they require for verification.
Overall, friendly loans can be an excellent option for people who require financial assistance. However, it is essential to be aware of the risks and prepare to face the consequences if you cannot repay the loan. Proper preparation and communication make friendly loans valuable for difficult financial situations.
Joseph Priebe takes pride in assisting audiences with his articles to help them make sound financial decisions.
With over ten years of experience writing financial content his goal at CASH 1 has always been creating engaging and easy-to-digest information for anyone searching for immediate or long-term monetary solutions.
When Joseph is not writing about personal finance, you can find him photographing the Southwest United States with his 4x5 Graflex Crown Graphic camera. He is based in Phoenix, Arizona.