By Lynnette Khalfani-Cox, The Money Coach®
A few years ago, the Federal Reserve Board Survey of Consumer Finances pegged the amount of loans between family and friends at a staggering $89 billion annually in the United States.
More recent research, however, puts family and friend borrowing at twice that level.
For example, a 2017 survey from Finder.com revealed that with the growth of digital wallets and payment services like Venmo, Americans are in hock to those closest to them to the tune of $184 billion a year. Meanwhile, a national survey by Fundable, found that 38% of startup entrepreneurs relied on money from family or friends. And the National Association of Realtors says 6% of first-time homebuyers get money from family to buy a house.
With so much borrowing going on, it’s worth considering if it’s really a good idea to loan money to family members or friends? And what about co-signing a loan for a family member or friend?
Here are the pros and cons of putting your cash at risk or signing on the dotted line for someone – whether for a mortgage, business loan, student loan or another form of credit/debt.
The Pros of Loaning Money
Obviously, if a family member or friend is in dire straits, the idea of helping the person out may be appealing — to both you and to the individual you might provide a loan. In this case, family ties or mutually strong feelings of kinship might be all that you need to say “Yes” and to view your assistance as a positive thing. In some cases, you might also structure a loan to receive interest; so that could be deemed as an added plus.
Finally, coming through for a family member or friend in their time of need will most certainly be appreciated. So your willingness to provide a loan, or perhaps co-sign may deepen the bond you share, or even make your relative or friend more likely to help you out down the road if you request it.
The Cons of Making or Co-Signing Loans
For all the positive personal feelings that may arise from you coming to someone’s aid in the form of a loan, you need to understand that the opposite scenario could just as likely occur. There are many, many stories of financial loans gone awry among family members and friends— leading to bitterness, hurt feelings and sometimes destroyed relationships. So you should carefully consider this reality before you co-sign for someone or loan another individual money.
Another risk: if you’re co-signing for another person on a credit obligation, you could be on the hook financially and legally for the loan. That’s the case for all kinds of credit obligations, including credit cards, cars, as well as financing for homes or higher education. In short, if your relative or friend fails to pay, creditors could come after you for the money.
Therefore, you should ask yourself if you are prepared to repay a debt if the person asking you to co-sign cannot or does not pay for any reason.
Finally, be aware that you are putting your credit on the line any time you co-sign for someone else. Not only could your finances take a hit but your credit rating could be blemished by late payments, collection accounts, defaults or judgments if your family member or friend doesn’t pay as agreed. But since family loans are a big reality in America, perhaps it’s best to adopt what some say is “the right way” to do loans if you are so inclined. The right way involves drawing up a written loan agreement with key terms specified including the loan amount, the repayment length and terms, as well as provisions that both parties agree to in advance in the event the loan is not repaid as promised.
At least by taking these steps, you’ll be doing what you can to prevent loans and money issues from ruining your relationships with those you love.
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