Lending and borrowing between family and friends is a common form of finance in the UK and across the world. From lending someone a tenner here and there, borrowing from our loved ones extends far greater to include things like:
- Car purchases
- Home deposits and rent
- Vehicle insurance
- Paying off debt
First time buyers increasingly use “the bank of mum and dad” as a way to get on the housing ladder, with parents paying for at least 25% of the deposit of a new property. Parents also feel the obligation to help their children maintain a good financial position if they fall on hard times for things like credit card and student debt.
But unlike applying for a short term loan with Uncle Buck, the unwritten rules of borrowing from people we know and love are very different. It is unlikely for there to be written agreements or interest charged when borrowing from loved ones and whilst it is sometimes successful, it can also cause conflict and fall-outs.
The benefits of borrowing from family and friends
More trusted: Several individuals will prefer to borrow from someone they know and trust, rather than an unknown lender or their bank. The role of people is something that has decreased more and more in recent times since the day of the bank teller with most loan applications now processed online.
All credit considered: For those with adverse credit, they do not feel the risk of rejection by borrowing from friends and family who are willing to offer money based on their word and their long standing relationship. This can help those with poor credit to get back on their feet or cover outstanding debt repayments. It also avoids any potential search footprints showing up on their credit file which can reduce their eligibility for a loan if they have accumulated several in a short space of time.
Faster: Rather than visit your local bank or fill in an application form online, the process of borrowing from a parent or sibling can sometimes be much quicker. With documents rarely involved, individuals will typically receive a quick bank transfer or cash in hand from their family towards the expense.
No repayment: According to a study carried out by One Poll, it is only around 50% of family members that expect any form of repayment. Compared to the rates charged by mainstream lenders, the idea of having an interest-free loan can be very appealing.
Borrowing without interest
There are several transactions between friends and family where no interest applies. This is for simple transactions between friends for very small amounts like £5, £10 and £20. The amount is so insignificant that 41% of those polled said that they would not bother asking for it back (Source: The Mirror). There is also the feeling that the amount is so small, that even asking for it back would be petty and lead to confrontation.
There is also the sentiment that parents want to give money to their children out of love. Whether it is celebratory or because they have fallen on hard times, parents will sometimes feel obliged to cover costs for things like broken boilers, medical visits and car repairs if they can afford to do so.
Borrowing with interest
Some parents, siblings and friends may insist on charging interest as this is a way to formalise the agreement. Especially if you need the money for a short period of time, the idea of borrowing £100 and then repaying £110 this time next month, can seem like a logical way to approach loans amongst friends or family.
There have been several successful businesses that were founded with help from money from parents including Poundland, Amazon, Ann Summers and Ella’s Kitchen. The idea of borrowing the money and then repaying the money back after a year with 10% interest has certainly worked for some successful entrepreneurs.
Tips to avoid conflict when borrowing from family and friends
The Mirror explains that 55% of people regretted borrowing from family and friends and 1 out of 10 ended in a falling out. Therefore, stakeholders need to be careful when addressing this proposition.
MoneyAdviceService recommends having a basic but formal agreement in place between all parties involved. This includes the loan terms, amounts, interest, date of repayments and what happens if payment is not made. Once signed by all parties, there is a better understanding of everyone’s expectations and both parties are therefore prepared for any eventuality.
In addition, it is important to consider your budget and what you can realistically afford. At Uncle Buck, we carry out thorough affordability checks to understand how much an individual can repay each month without falling into financial difficulty. This approach can be very useful when borrowing from people you know too. For instance, by reviewing your living costs and disposable income, you should calculate how much you can borrow from your friend or family member without compromising your financial situation.
Similarly, you should not stretch your family member to lend you money that they cannot afford either. Will your loan require your parents to get a second mortgage? You should also ask how much they can afford to lend you without damaging their own financial position.
Alternative ways to borrow from friends and people
For those parents or siblings unable to lend large amounts, there is the option to be a guarantor for them. This means that you co-sign the loan agreement with the individual and only repay the loan if they cannot keep up with payments. For the parent or sibling that acts as a guarantor, there is no upfront cost or money to pay, they simply act as the cushion in case the loan repayments fall through.
This is common for first-time buyers looking for a new property and they are known as ‘guarantor mortgages.’ In fact, having one’s parents as a guarantor adds so much security to a loan agreement that some mortgage providers are willing to offer as high as 100% loan to value (LTV).
Peer to peer lending also allows you to borrow from other people, but anonymously. These people are investors looking to secure a better interest rate than their bank’s savings account. Using a peer to peer lender as the middleman to handle the transaction, applicants can apply to borrow up to £25,000 and investors can receive returns of 3.3% per annum if they lend to good credit customers or rates as high as 9% if they lend to customers with bad or poor credit history. (Source: Zopa)