Whether you’ve run into unexpected expenses, want some help with a large purchase or need cash to move your business idea forward, there’s a variety of reasons that you might consider turning to friends or family members to borrow money.
The Federal Reserve benchmark interest rate is at 5.4%, its highest level in 22 years. That puts the prime rate, available to the most qualified borrowers, from most financial institutions above 8%.
While borrowing money from friends and family can be a lower-cost way to access funds – or the only way, if you have a poor credit or no credit history – it can also create challenges for relationships.
If you are planning to borrow money from your friends or family, keep these five tips in mind:
1. Be Transparent About Why You Need the Cash
Asking a loved one for money – even if you’re planning to pay them back –can be an uncomfortable situation. The best approach is honesty. If you’re asking them to trust you with a loan, you should trust them to know the reason for the request.
“The more work you put into the conversation on the front end, the more stress you can alleviate or avoid on the back end,” says Andy Smith, executive director of financial planning at Edelman Financial Engines in Santa Clara, California.
Lay out how and why you’re going to use that money and explain why it’s important for you to get access to the cash now.
2. Be Prepared to Accept No for an Answer
Your friends and family are under no obligation to lend you money. There are myriad reasons that they may decline your request, from concerns about mixing business and personal relationships to their own financial needs. If they say no to your request, they don’t owe you an explanation.
3. Establish the Terms In Writing Upfront
Often, when loans go bad between friends and family, it’s because the loaner and the borrower had different understandings of the deal. By setting expectations at the start – and putting them in writing – you can eliminate miscommunication that could potentially create resentment later.
“You want clear-cut communication,” Spiro says. “The last thing you want is for this to turn into a ‘he-said, she-said’ situation.”
The loan agreement should include the amount you’re borrowing, the amount (if any) of interest you’ll pay and the date by which you plan to complete repayment.
4. Have a Plan to Pay Back the Loan
Before you even ask for the cash, think about how and when you’re going to pay it back. If your plan is to make ongoing payments, look closely at your budget to see if you need to make changes in your spending to free up the cash.
“If you’re the borrower, you need to treat this like any other financial transaction,” Smith says. “Just because it’s family doesn’t mean that it’s any less important to account for in your budget.”
5. Let Your Lender Know if Circumstances Change
The key to protecting your relationships after borrowing money is being as honest and transparent as possible with your lenders. If something happens that leaves you unable to pay back the loan in accordance with the terms to which you agreed, let your lender know as soon as possible.