Loans from family or friends

There are times in life when you may need to borrow money from a family member or close friend. Borrowing in this way can be a lifeline, when other types of formal credit or loan may either be too expensive or inaccessible, for example.

But taking a loan from someone close to you is not a decision to be taken lightly. Our guide covers the things to consider, with hints and tips on how to keep the borrowing arrangement on track – and not affect your relationship.

What to consider before borrowing from family or friends

There are several questions to consider before borrowing from family or friends. These include:

1. How will it affect your relationship with them? - Consider this carefully as often being financially linked can put pressure on a personal relationship. Be confident you are both content with the loan and the arrangements before proceeding.

2. Will they feel they can say ‘No’? - If the potential lender feels you are in a tight financial position they may feel obligated to help. While this might not be a problem in some cases, it’s worth considering what your response would be. Do you want to put them in that position?

3. Would I be better borrowing the money elsewhere? - While borrowing from family or friends might seem like the cheapest option, it is not the only one. Other borrowing is available, such as personal loans, secured loans and guarantor loans. This might be more suitable for you.

3. How will repayments be structured – and can I afford them? - You’ll need to agree together how loan repayments will be structured, how long loan repayments will last and whether interest will be charged – and how much. Our loan calculator can help you work out how much you should pay.

4. Should we make the loan a formal written agreement? - It might seem like unnecessary hassle at the outset of the loan, but it is often a good idea to write something down to give you and the lender clarity over the arrangement. It will also offer protection should the relationship break down or you cannot afford the repayments.

When should I take a loan from family or friends?

There are many reasons why you may need money ranging from spending on relatively frivolous items to essentials such as food and heating. Below are some of the times when it might be appropriate to ask family or friends for a loan.

When paying bills: If you’re struggling with the cost of living, such as paying utility bills and feeding your family, then a loan from friends and family might help. The risk is that it’s a longer term problem that needs addressing and often the loan will only cover costs for a while. As such, you should also seek other alternatives to lower costs/ increase income, and also seek Government support if available.

When clearing debt: If you have built up a lot of debt and are paying high interest rates, a loan from friends and family might help you clear some or all of what you owe. Even if you agree a repayment plan with your loved ones that includes interest, it may be a lot less than you’re paying to a loan or credit card provider.

When buying a house: Buying a house is often the biggest purchase we make, and it can be difficult to save up a big enough deposit. Borrowing extra from friends and family for the down payment may be helpful. But this needs to be considered in the context of other borrowing. For example, if the loan is alongside a mortgage on the property, can you afford both? You are also obliged to tell your potential mortgage lender if the money is a loan (not a gifted deposit) as they’ll factor it in when assessing your affordability.

When planning a wedding: Alongside buying property, paying for a wedding is likely to be another large one-off expense where you could approach family or friends to help. Wedding costs can quickly spiral so be conscious about how much you are likely to need and – just as with other borrowing – whether you’ll have the capacity to pay it off after the big day

When buying a car for work: While getting around under our own steam can be expensive, depending on where we live and work, it may be the only option. Friends and family may be prepared to help with a loan here too. If not, there are other ways to finance a car that you could consider.

Paying for education: Most graduates in the UK pay for their education through a student loan, so borrowing from friends and family could be a way of helping with living expenses if your studies are being affected through money worries. As with all loans, make sure you have a plan to pay it back.

What are the pros and cons of borrowing from family or friends?

It’s important to weigh up the pros and cons before borrowing from family or friends. Here are some things to consider:

Advantages

• You may be able to borrow at a much lower interest rate – or even zero interest

• You’re unlikely to face fees and late payment charges

• You won’t have to be undergo a credit check to get the loan

Disadvantages

• You could damage your relationship if you struggle to make repayments

• You may breach the terms of other borrowing, such as your mortgage, because any loan affects your affordability

• The friend or family member may not want to say ‘no’ but they could run into financial difficulties of their own

Should I write up a formal loan agreement?

It makes sense to write-up a formal loan agreement – even for very small amounts. If you have something down in writing at the start that is signed, it can help with disputes later on. A written loan agreement can benefit both parties because you can use it as protection if one of you breaches the terms.

What are the tax implications of borrowing from friends or family?

If the loan is to be paid back with interest – even if the rate is low – there are tax implications for the borrower and the lender.

The lender must declare any interest received as taxable income, and – if it’s a business loan – the borrower may deduct loan interest from the taxable profit of the business.

If the loan is interest-free, there are no tax implications for either borrower or lender.

What should I do if I am unable to pay back the loan?

If you are unable to pay back the loan – or think this might be a possibility – speak to the friend or family member you owe as soon as you’re aware of the issue. This will show them that you are being upfront and honest, and it can help protect your relationship.

Between you, you will hopefully be able to restructure the loan. This could either be through a pause in repayments (a payment holiday for a time) or agreeing for you to pay less back each month over a longer period. They may even be prepared to accept a drop in interest rate.

The important thing is that you’re both happy with the new arrangement. Draw up a revised written agreement so everything is clear and you’re both protected.

If you’re the lender and the borrower refuses to pay back the loan, try and discuss the situation amicably. If this fails, you could try mediation with a third party to find terms you both agree on. Failing that, if you have a written agreement in place, you could look to take legal action – although this will incur further costs.

Is it a good idea to lend to a family member or a friend?

It depends on a few factors.

1. Can you afford it? If you are putting yourself in a financial hole through lending the money, then it’s almost always the wrong thing to do.

2. Do you trust them? While you can draw up written agreements, there should be an element of trust between the two of you, so you’re confident they can and will keep up with repayments.

3. Do they have good financial habits? While you may not know all the details, viewing their lifestyle can often give clues as to whether they can handle taking on the debt. While they may set out with good intentions, if they struggle with the discipline to budget the situation can quickly unravel.

4. What will happen if they can’t repay? Consider the worst case scenario of them not being able to pay off what they owe you. Are you content to write-off the money? While both of you will hope this doesn’t happen, none of us can predict the future. If you can’t bear the prospect of not being repaid, seriously consider whether you want to give the loan in the first place.

Finally, think carefully about how a loan might affect your relationship. Most of us have different attitudes towards money and despite best intentions if you lend money to someone close to you it could change your relationship with them – and resentment can creep in. For example, how would you feel about them going out and spending money on something you felt was frivolous knowing that they owed you hundreds of pounds?

What are the alternatives to borrowing from family or friends?

There are a range of borrowing options if you need a loan. Here are some things to consider:

Personal loan: A personal or unsecured loan allows the borrower to keep their financial independence and not have to turn to family or friends for help. The challenge might be that interest rates are higher and only the best deals are available to those with excellent credit scores.

Secured loan: Allows you to put a valuable item, such as your house, up as collateral should you be unable to make repayments. Secured loans can allow you to find better deals at lower rates, but the risk is that if you can’t repay the loan your property is at risk.

Guarantor loan: You borrow from a loan provider, but a guarantor – usually a family member or close friend – guarantees that they will step in if you can’t keep up with repayments. Can help borrowers with poor credit ratings get a loan, but interest rates also tend to be higher than for other types of borrowing.

Gifted deposits: Used in the case of buying a first home, for example, a gifted deposit is a much cleaner financial arrangement than a loan because it is a one-off with no expectation to get any money back.

Peer to peer loan: With a peer to peer loan you can borrow money directly from other people – without the need of a bank, broker or other middleman. Loans are provided by individuals through a peer to peer platform, which will set the interest rates and the terms and conditions of the loan. Peer to peer lending is regulated so borrowers have access to the Financial Ombudsman Service, should they need to complain about their loan.

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