MY MONEY

The real cost of lending money to family and friends

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We've all been there. You're hard up for cash, but don't want to go to a bank or payday lender. In times like these, a loan from a friend or family member can seem like an easy fix. But it's a route fraught with danger.

When you get a loan from a finance provider, the worst that can happen is you default, debt collectors arrive at your door and your credit score takes a hit. Friends and family, on the other hand, don't have access to credit files. If you don't pay them back, or they don't pay you, your credit worthiness will be unaffected.

But that's where the advantages end and the problems begin - and it goes far deeper than finance.

loaning money friends and family

If you are lending a small amount of money you may not be overly concerned about being repaid, "you may write it off as a gift", says Genene Wilson from Finesse Financial Advisers.

"Ask yourself, though, if you are setting yourself up for many more 'gifts' in the future."

Enlisting the services of a lawyer, who typically charges between $200-500 an hour, to sort out a loan gone bad is out of the question. An hour's consultation could exceed the amount you're out of pocket from the loan.

Then there's the social cost.

"There's also a host of other complexities that you need to keep in mind, such as the influence of partners, in-laws and your other family members who will have a vested interest in the arrangement," says Suncorp behavioural economist and psychologist Phil Slade.

"Loaning to family is rarely a simple agreement between two parties, and therefore that more complex context needs to be taken into consideration whenever terms of an agreement between family members is being negotiated."

Loans between friends and family can also violate untold expectations.

"How would you feel if a family member owed you a significant amount of money, but then sent their kids to a relatively high fee paying school, or went and bought a new car?" Slade says.

"They might be repaying you according to the terms of the original agreement, but as you're unlikely to be earning interest on the loan, this still feels like you're being taken advantage of in some way."

There's usually nothing in it for the loan provider, beyond the social kudos. These loans usually don't have interest rates, "which means the lender has not just lost that money temporarily, but also the ability to invest or earn interest from that money in some way, shape or form."

All this is not to say that loans between family and friends are impossible without risking total relational breakdown.

Being open about expectations, especially timeframe for repayment, is key.

"Set up clear rules, but then make sure you have points in time where you can revisit those rules in a safe way to accommodate for change," says Slade.

"Remember, money and family relationships are two of the most emotional triggers we have, and mixing them together can be dynamite - so handle with great care."

Even semi-formal loan agreements can provide much-needed formalisation.

For those who want to move past paper agreements, apps such as Credi allow lenders and borrowers to work out all the terms and conditions of the loan. Agreements are then e-signed and repayments tracked via a phone app or online.

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David Thornton is a journalist at Money magazine. He previously worked at Your Money, covering market news as producer of Trading Day Live. Before that, he covered business and finance news at The Constant Investor. David holds a Masters of International Relations from the University of Melbourne.
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