Borrowing
How to borrow money from friends (and stay friends)
Links to external websites are not managed by Varo Bank, N.A. Member FDIC.
All Varo products and services mentioned below are contingent on opening a Varo Bank Account. Qualifications may apply.
All of us can use a helping hand from time to time. Although it may be difficult to ask, borrowing money from friends or family members can have its benefits, both for you and those who you’re borrowing from.
You can avoid dealing with credit checks and applications, keep the money “in the family”, and settle on an interest rate that’s potentially lower than you could find elsewhere (but still offers the lender more earnings than the average savings account).
However, It’s not hard to imagine (or have witnessed firsthand) situations where loans between friends or family members don’t work out so smoothly. Missing payments can lead to strained relationships or awkward family interactions. Even when repayments go to plan, the outstanding debt can add a new (and sometimes unpleasant) dynamic to any relationship.
There’s no magic trick for making sure the loan works out, which is why some people advise against borrowing money from friends and family members altogether.
Whether you’re considering borrowing as a last resort or as a better alternative to other loan options, setting some ground rules is definitely a smart idea.
Create a contract for borrowing money
Even if you and the person you’re borrowing from completely trust each other, creating a written contract can still be helpful. Such contracts are generally called promissory notes when you are lending or borrowing money.
At a minimum, you want to clarify the following.
The loan amount and purpose
How much interest will be charged?
The repayment terms, including how often the borrower will make a payment and each payment amount
What happens if the borrower can’t make a payment?
Who will mediate disagreements?
In most cases, you probably don’t need to go as far as using a lawyer or a full legal document unless the lender wants a plan for enforcing repayment of the loan.
The intent of the contract is to avoid conflict by making sure both parties have clear expectations, and a plain-language letter can sometimes serve this purpose better than a potentially confusing document. However, if it’s a large loan, going through an attorney and drafting a more formal contract might make sense.
Discuss the potential downsides for your relationship
You’ll probably need a fair amount of open and honest discussion before you come to an agreement. Even if the conversation is difficult, it’s important to conduct it from the get-go in order to help avoid not seeing eye-to-eye in the future.
For example, if the borrower doesn’t make a payment after losing a job or falling ill, is this treated differently than if the borrower skips payments for something the lender considers a “want” rather than a need? In that same vein, can the lender ever put limits on how or when the borrower spends money?
Or, in a worst-case scenario, what happens if the borrower dies? Is the loan amount forgiven or does the lender expect to get paid from the borrower’s estate, potentially creating tension between the borrower’s heirs and the lender?
Using “borrower” and “lender” helps take some of the emotion out of the initial discussion, but it’s always worth considering how the arrangement looks on paper if family gets involved during worst-case scenarios.
Gauge the other person’s financial capacity
Whether you’re borrowing or lending the money, it’s important to understand how the loan will impact the other person’s finances.
If you’re the lender, you want to know that the borrower can afford to repay the loan as long as there aren’t any major surprises. Alternatively (and this greatly depends on the situation), treat the loan as a gift and know that there’s a chance—but not an expectation—you will not get the money back.
If you’re in need of money, whoever you ask may feel compelled to say “yes” as a favor. But, borrowers should also want to make sure that the loan won’t strain the lender’s finances too much.
If it seems like the loan might not be the best idea for either party (or both), it might be best to move on and manage the temporary financial crunch in some other way.
Consider any tax implications
Although you might feel like this is an under-the-table or casual arrangement, it’s important to consider the applicable laws and tax consequences.
For example, the IRS might automatically calculate and add interest to your income if it finds out you lent money to someone else, even if you didn’t charge the person interest. However, if you’re lending or borrowing less than $17,000 without interest (the gift-tax exclusion amount as of 2023), the IRS may view the exchange as gifting and you won’t need to worry about taxes.
On the other end of the spectrum, most states have usury laws that limit how much interest you can charge on a loan. Often, this ranges from about 10% to 20%.
If you’re concerned with the tax implications of your arrangement, it’s probably worth contacting a local attorney or accountant to help you work through any applicable federal, state, and local laws.
Start with a small loan
If it’s your first time borrowing from or lending money to friends or family members, it can be beneficial to test the waters with a small loan. You may find that it eases some of the burden of a more formal, higher-stakes arrangement. Or, you may find that even if the small loan is repaid in full without any problems, you simply don’t want to take part in such an arrangement again.
Most of us have either been there or can understand what it feels like to undergo financial hardship. If you need to turn to a friend or family member for help during tough times, it’s wise to weigh all pros and cons to help ensure it makes financial sense for both of you and doesn’t strain the relationship.
Unless otherwise noted above, opinions, advice, services, or other information or content expressed or contributed by customers or non-Varo contributors do not necessarily state or reflect those of Varo Bank, N.A. Member FDIC (“Bank”). Bank is not responsible for the accuracy of any content provided by author(s) or contributor(s) other than Varo.
Showing post 105 of 135