Banks have tightened their lending standards, so it is more difficult to borrow money—even for those with strong credit histories. Some people are turning to friends and family to borrow funds, but the Pennsylvania Institute of Certified Public Accountants (PICPA) cautions that smart steps are needed to prevent the loan from damaging a good relationship.
Borrowers who fail to repay bank loans can face legal problems; those who can't make good on loans from friends or family can be hit not only with legal trouble but also the loss of a personal relationship. It is always a good idea to think about all your other options before approaching someone you're close to for a loan. Try more than one bank, for example, or explore the borrowing possibilities at credit unions or other sources. It may also be possible to cut back on your spending instead of taking a loan or to postpone plans for a big purchase until you have saved the money you need.
Get It in Writing
One potential pitfall of a loan between friends or family is the informality. A handshake is a popular way to cement a deal, but a written document would be better for both sides. Problems will arise when the friend lending the money expects it to be returned within a short time, while the borrower believes he or she can pay it back over an indefinite period. To protect your relationship and your wallet, put the conditions of the loan in writing. Record the amount of the loan, when and how it will be paid off, and if any interest is to be paid. If interest is less than the applicable federal rate, the foregone interest may be taxable interest income to the lender. These imputed interest rules do not apply if the total outstanding loans between the parties is $10,000 or less. This kind of promissory note clarifies the borrower's responsibilities and can help prevent misunderstandings later. The note should be signed by both borrower and lender, and each one should keep a copy.
While written documentation is a great idea, remember that it may not prevent payment problems. Therefore, both parties need to be realistic before they enter into the deal. If you know that a loved one likely won't be able to repay you, offer instead to help him or her solve their problems by developing a monthly budget or working out a payment plan with creditors. If you are uncertain you will be able to repay a loan, consider asking loved ones to brainstorm other borrowing options. Doing so may preserve your relationships.
Give Honest Updates
If you borrow money from a friend or family member and find that you are unable to repay it as expected, let them know about the problem right away. Explain what went wrong and when you think you will be able to make good. It may be a difficult conversation, but your candor and consideration for the other person will go a long way in helping to preserve the relationship.
Consult Your CPA
No matter what your financial concerns, be sure to turn to your local CPA for advice. He or she can help you find answers for all your financial questions. To find a CPA in your area, visit www.IneedaCPA.org.