Borrowing money from family: 3 questions to answer before you do it

They say money changes everything. That can be especially true when it comes to borrowing from a friend or family member. Even the heartiest relationships can be put to the test when that line is crossed and you become creditor and debtor. What seems like a simple, short-term transaction in the beginning can cast a long, dark cloud over family and social functions. Before hitting up a pal or brother-and-law here are some things to think about.

Do I have a better alternative?
It’s good to explore alternatives for two reasons: to avoid the risk of souring a good personal relationship and to show friends or family members all attempts were made before turning to them. Going to them first suggests they are an easy source of money and could imply you are not serious about paying them back.

Applying for a formal loan from a financial institution beforehand could also help establish a long term credit rating if you need to borrow in the future. Start with the bank you do business with. The prime lending rate at most banks is currently 3 per cent but that’s the rate for preferred customers with a long history of repayment and plenty of collateral to back up the loan. If you can back up the loan with collateral, such as equity in your home, the rate can be as low as 3.5 per cent.

The rate on a basic unsecured consumer loan depends on the individual and the amount borrowed but is generally much lower than interest on credit card balances, which are usually in the high teens.

If your debt problem is well beyond that, consider credit counseling. A lender is more likely to lend if they know their money is part of a plan to keep you from coming back for more.

Do I have the details worked out (and written down)?
If all alternatives have been exhausted chances are you are a credit risk. In pure business terms that means you would pay a high interest rate.

But dealing with family or friends is not pure business. Your word is your collateral, and the lender must decide the value of your word.

Regardless, you should approach your potential creditor with a written plan including the amount you want to borrow, the rate of interest and a timeline for regular payments ending on the day it is paid in full. Several financial websites have debt calculators to work out the details.

You should also offer details of your financial affairs. Any lender would likely be wondering if your income can cover the plan. They may also be concerned that the loan will merely buy time while you sink deeper in dept paying interest to other lenders. Either way they should be given the opportunity to examine your personal finances to see if there are fundamental problems in the way you manage your money and perhaps make suggestions to avoid perpetual debt.

Do I have a plan to avoid the situation getting weird?
Depending on your relationship, a friend or family member might provide an interest-free loan - no questions asked, no strings attached. If you are out of work and unsure of future income they probably already know that and may leave the terms of repayment open.

It’s their money at stake but it’s your pride and reputation on the line, so don’t get angry if they ask questions. A great way to avoid that is to send periodic updates by email and not dampen family or social functions with money talk.

If you feel higher interest debt should take priority say so, and ask for their opinion. They may also be experiencing a cash squeeze and need the money as soon as possible.

Allow them to be part of the solution. It could be a relationship builder.