Tips for Borrowing From (or lending to) Family and Friends

I posted this comment on Mint’s blog asking about people’s opinion on borrowing from family and friends:

We deal with this question a lot at Community Ladders, since we work with many young professionals just starting out who lack a strong credit history or who are pursuing jobs on Capitol Hill and in the non-profit sector that don’t pay well initially.

As a rule of thumb, borrowing from family is best avoided, but sometimes it can be a compelling option for both parties during this time of low-yield savings accounts.

However, I have our members write out formal loan contracts with loan repayment rates, timelines, total payout, and interest (I think one should ALWAYS pay some interest, typically around 2 to 5 percent). Sometimes we’ll even put in penalties in the case of missed payments, or build in a number of ‘grace months’ where a payment can be skipped without penalty. We also usually have a clause that if the lender needs the money back immediately, the borrower has 60 days to find another source and pay back the outstanding balance in full.

The important thing is to be explicit and set clear expectations for repayment (and then, of course, stick with it). As long as you are repaying the loan on schedule, your family shouldn’t be all in-your-business about what you are spending your money on.

This is certainly awkward to set up initially (our members get to blame it on me, since I often draw up the agreement for them and am rather insistent that they use such a contract), but trust us that it saves a lot of awkwardness, misunderstanding, and anger down the road.