This article was published on 1 November 2005. Some information may be out of date.

Borrowing tricky between family or friends

A quote recently caught my eye. “The easiest way to teach children the value of money is to borrow some from them,” it said.

But that applies not only to children. Adults, it seems, take much more notice when someone has borrowed from them than when someone has lent to them.

In a recent BNZ survey, 55 per cent of respondents said friends had borrowed money from them, but only 21 per cent said they had borrowed from friends.

Did the survey somehow pick people less inclined to borrow than average? It’s more likely that people recall what makes them feel comfortable.

What’s more, of those who admitted to borrowing from friends, 90 per cent said they had always paid back the money. But lenders reported that only 59 per cent of their friends had paid them back. More selective memory, no doubt!

Is borrowing between friends — or family members — a good idea? Done carelessly, it can wreck relationships.

I’m not talking here about $20 on a Saturday night that is, hopefully, repaid the next Monday. I’m talking larger amounts for longer periods — loans on which interest is charged.

The obvious advantage of such loans is that you cut out the middle man. The lender can get more interest, and the borrower pay less interest, than at the bank.

Also, you avoid form filling and hassle. And in some cases the borrower has no track record, or a bad track record, so a bank wouldn’t lend to them anyway. But a friend or family member might feel confident they will be repaid.

Whatever the situation, always formalise the loan. The borrower should write a letter to the lender, stating the amount, the interest rate and how often it will be calculated, and when and how the loan will be repaid.

Include a paragraph on what happens if the loan is not repaid on time. Will interest accumulate? At a higher rate? This might sound nasty, but if you neglect it there could be much more nastiness later.

The borrower should sign two copies of the letter, keep one, and give the other to the lender. The lender should keep a copy with their will so that if they die, their estate can collect the debt.

If the loan runs over several years, it would be good to include a paragraph that says every February 1st, or whenever, the borrower will send the lender a new letter stating the amount outstanding and any agreed changes in the repayment schedule.

Then make sure the annual review happens.

Such formality may seem unnecessary. But I’ve seen relationships sour because a borrower says they can’t repay a loan, and neither party knows where they stand.

An unpaid lender can become resentful, watching every dollar the borrower spends and thinking, “He can’t repay me, but he can buy booze,” or holidays, clothes or whatever. The borrower, meanwhile, feels spied upon, and starts avoiding the lender.

If, however, the two have agreed on a slower repayment schedule, such feelings are much less likely to arise.

A couple of other points for parents who lend to their offspring:

  • Consider offering the same deal to all your children. Or at least tell the other children what’s happening and why you are favouring one child.

    Openness seems to forestall many problems.

  • If some of your children are borrowing against their inheritance, tell all the family that is happening, and send accounts to everyone once a year.

    After you die, everyone will know where they stand, which can prevent bitterness.

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Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it.