The most common type of loan is a bank loan, but there is a second type, one that is often swept under the rug—and that’s the family loan. Applying for a bank loan involves the stress of never-ending paper work and high interest rates, so borrowing money from family or close friends can seem like a great option. But I’m here to tell you that borrowing money from family is never a good idea.
Here’s why—when you borrow money from family, you are making your financial problems their financial problem. The ultimate goal is for you to reach financial wellness, and borrowing money from family will not help you get there. That being said, if you have already borrowed money from family, you need to establish a plan to pay the money back.
The first step toward financial wellness is to be fully aware of your money situation. I’ve often had people come to me and list out their debts, and after we have moved on to budgeting, they will throw in, as an afterthought, “Oh, and we also owe $10,000 to my grandparents, but they don’t need us to pay them back right away.” No. It doesn’t work like that. In order to reach financial wellness, it is necessary to treat money owed to family as a debt like any other.
Here are my suggestions for navigating a family loan:
1. Make a plan. The goal is to pay down all of your debt, and that requires a plan of action. In order to set attainable goals, you will need to create a budget based off of your take-home pay. Determine what amount you can afford to pay each month toward the balance of your family loan. It may only be $20, but that’s okay—$20 is better than zero.
2. Be subtle. Many people who borrow money from family want to make the grand gesture of paying them back in one lump sum. Unless you suddenly find yourself in this position to comfortably do so, this is generally a bad idea. The subtle approach of making payments to your friend or relative each month is a much more sustainable long-term plan.
3. Send a card with your first check. Do you send a note with your mortgage payment every month? Of course not, but I think it is a good idea to write a note to your relative the first time you make a payment. I want you to treat this debt like any other in the financial sense, but this debt is relational, so it gets the special treatment.
Sending a personalized, hand-written note that includes your sincere thanks and an explanation of how much you can afford to pay at a time (and how often) can go a long way toward mending any tension in a relationship that has been tainted by debt.
4. Be consistent. The key in all of this is that you should be consistent in paying off the debt. I often hear the excuse that it is okay to skip a payment to family because the debt isn’t accruing interest. While that may be true, what we are ultimately trying to address here is the behavior associated with debt.
Borrowing money from family can seem like an easy solution to a bad financial situation, but don’t exhale there. If you must borrow money from a relative, make a plan to pay them back and stick to it. The debt may not affect your credit score, but it can affect your relationships—and those are far more important.
Peter Dunn, aka Pete the Planner, is an award-winning financial mind who has authored five books, hosts the popular Pete the Planner radio show and travels around the country offering financial education. His signature wit will have you laughing as you learn. For more from Peter, visit www.petetheplanner.com.