Personal Bank Loans vs. Family Loans

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The following is a guest post. Enjoy!

No one likes to be in debt, but taking out personal loans from time to time is often necessary, especially if the loan is for an investment – e.g. to buy a first house, finance your education, or get a start-up business off the ground.   
There are well-documented problems that borrowers can encounter with high-interest loans, whether that is caused by poor financial management, or taking out a reasonable loan but not understanding the terms. Even if we are unable to pay a loan back as quickly as we had initially agreed, there is help available for borrowers to consolidate their debt and get out from underneath it. In certain states and counties, debtors who get behind on their payments can actually wind up in private prisons run by contractors, even though debtors’ prisons have been mostly illegal in the USA since the Civil War.
However, if you find yourself blessed with friends or family who have disposable cash to hand (and like you), there is a great temptation to take a loan from a personal acquaintance instead of a bank or lending institution. And, it makes sense: it’s often quicker and easier, with less red tape and better terms (perhaps your friend or family member has even offered to let you pay back the loan interest-fee), and on a whole, it somehow feels less scary; no paper-work or intimidating payment reminders from the bank. But as they say, buyer beware.

Are family loans worth it?

The danger with borrowing money from someone you know is that money can become a divisive issue; indeed, it is an issue that has been known to destroy relationships and ruin friendships. In fact, an overwhelming number of marital problems and divorces are down to money-related conflicts, which should serve as a strong caution to even the most amiable friend or relative who might offer you financial help.
One major stumbling block with family loans is that people may not be honest with you – i.e., the money may be more important to them than they initially indicate. The importance of recouping that money, and the lender’s expectations as to how quickly you’ll pay them back, often goes unstated.
Furthermore, you may take their generosity for granted and assume they’ll ‘let it slide’ or that they’ll understand if you can’t make your repayments every month. It is easy to allow one month of non-payment turn into two months or four; sometimes, it turns into a year, with the hope or assumption that the loan has been forgiven. It is easy to imagine how this might fracture the relationship.
An interesting study was conducted by Carnegie Mellon University – we have a tendency, especially in situations where we are borrowing money from a friend or family member, to confuse fairness with self-interest. So at the end of the day, which is more important to you: money or your relationships?

How about you all? Would you be willing to give a loan to a family member or have you ever taken out one of these? If so, how did it work? Did it create any family stress? Did you have a written agreement?

Share your experiences by commenting below!

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  1. Julie @ Freedom 48 says:

    I've always been a firm believer to not mix money and family. Family loans are a big NO in my books! If your family wants to help you buy a house, and they want to give you money towards the down payment, that's one thing, but to loan money, with the expectation of being paid back is dangerous. You never know what unfortunate events can pop up in your life, and if those events cause financial difficulties which prevent you from paying back the loan… it can damage your family relationship. It's so not worth it!
    My recent post Do You Need a Will?

  2. Jules@FGSW says:

    For me, it depends on the person, and our situation. My grandparents loaned us $4,000 dollars for our down payment on our house. It was December, and we were going to repay them when we got our tax return. It went very smoothly and they were paid back by February. I am grateful and blessed that they did that for us. We wanted to buy the house because our payment would be cut in half by 500$ a month. It definitely is dangerous, and I HATED having the money out until we repaid them, but I am glad we did it.
    My recent post Plumbing And The Family Tree: The Roots Run Deep

    • Hi Jules! It seems like it was a pretty safe bet in you all's case since you knew pretty much exactly where the money for repayment was coming from.
      My recent post You Don't Know What You Don't Know – A First-Hand Account of the State of Personal Finance Education

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