Before any type of informal loan is provided, it's important for both sides to understand what they're agreeing to.
Putting things in writing can help, as well as checking that the lender will not fall into financial difficulty themselves from making the loan.
There are alternatives to borrowing from friends and family such as credit unions and mainstream lending like credit cards.
How to borrow safely from family and friends
Borrowing from family and friends can be a difficult experience, but there are steps both sides can take to make it a safer one.
One of the key elements of successful borrowing from family and friends is clear communication between both parties. It's important that both sides understand the terms of the agreement and are committed to meeting them.
What to think about
The person looking to borrow money should consider the following issues before they ask a family member or friend for a loan:
- How much money they need to borrow?
- What do they intend to use the loan for?
- How are they going to repay the loan?
- What are the consequences of not repaying?
It's more likely a request to borrow from family or friends will be successful if it's for a specific purpose.
So, a family member is more likely to loan money to purchase a new washing machine because the old one has broken rather than for a non-essential purchase like a games console or a holiday.
It's also important to provide a clear plan for repaying the loan, whether this is getting another job, more hours or cutting back in other areas to repay the debt over a specific period.
For the potential lender, there are some different things to consider:
- Will lending the money have financial consequences for them?
- Do they want to lend the money or do they feel pressured?
If making a loan to a family member or friend will put the lender at risk of financial difficulty themselves, it's important to find a way to say no.
Equally, if a person doesn't want to make a loan because they don't think they will be repaid or just don't want to enter into such an arrangement, that's within their right and they should not feel compelled to lend money in those circumstances.
There are alternatives to borrowing from family and friends we discuss in more depth below - consider pointing the potential borrower in the direction of those instead.
If the problem is that the situation seems too informal, there is another option: make it more formal.
Making the informal formal
If a personal loan is going to be treated as seriously as a bank loan, more than talk might be helpful.
A loan agreement will get the terms, time frame and interest of the loan down in writing.
If a repayment plan is specified, the document would also outline what happens if the borrower defaults on a payment.
Provisions could include a fixed penalty or an interest charge. Interest rates are often set so that the lender does not lose money over the period of the loan.
Agreements can also cover both parties in the event of all potential eventualities, however unlikely or disagreeable. For example, it covers what will happen if either the lender or borrower dies.
There are website services to help with this, like LawDepot, which offers a free draft promissory note that sets out the relevant details of a loan. Once filled out, this note can be taken to a solicitor who can act as a witness to signatures made by the borrower and lender.
There's a template loan agreement here, which can be used in a similar manner.
The problem with these solutions is that they are not regulated in the same way professional lenders are, so there can be little legal recourse if things go wrong.
If in doubt, it can be worth obtaining advice from a legal advice service. Some free advice centres, such as Citizens Advice or community law centres, may be able to offer pointers.
Dangers of informal lending
Some people feel uneasy about borrowing/lending between family and friends and there are some common themes and dangers to be aware of:
- Broken promises or agreements
- Confused assumptions about the loan
- Illegal lending masquerading as informal lending
Let's have a closer look at these.
We've already covered this above, but it's worth thinking again about the consequences of breaking an informal lending agreement between family or friends.
If the loan isn't repaid or there are difficulties in repaying, how is that going to affect the relationship and the financial situation of the lender?
Any borrowing between family and friends must have a clear agreement that covers:
- How much money is being borrowed
- What interest and charges will be applied
- How long the loan is for
- What the penalty will be for not repaying
If there is any confusion about these questions (or if the lender thinks the money will be repaid and the borrower doesn't intend to repay it), there's a danger the relationship will be damaged and the money won't be repaid.
There's also the danger that informal lending could be masking illegal lending, also known as loan sharking
If a person is offered a loan from someone they barely know or don't have a close relationship with, this could be predatory lending rather than an informal friendly agreement.
This type of unregulated lending could be dangerous and there are no restrictions on fees and interest, meaning the charges could soon mount up if a borrower is unable to pay.
What are the tax implications to informal lending?
It's also worth noting that there are tax implications for informal lending.
If a lender receives any interest on a loan, then they must inform HM Revenue & Customs, as this amount may be liable for taxation as income.
Lenders must declare the received interest on their self-assessment form as a taxable form of income. Loans that are interest free do not require the recipient or the benefactor to pay tax.
If a sum of money is given as a gift, rather than a loan, then it is free from inheritance tax up to the amount of £325,000. This is only true if the donor lives seven years after the payment is made.
Exceptions to this rule are that a person can give up to £3,000 per year without paying tax and up to £5,000 if the money is given as a wedding gift by a parent to their child.
What are the alternatives to family loans?
All in all, the potential for future misunderstandings and the legalese required means that borrowing from a friend or family member can sometimes be more trouble than it's worth.
Many people looking to borrow money in this way think they won't get credit through conventional channels such as:
- Arranged overdrafts
- Credit cards
- Personal loans
If someone has a poor credit rating, they may struggle to get credit from those lenders, but there are other options such as:
- Credit unions
- Local authority grants
- Peer-to-peer lending
We don't recommend payday lenders or other high-cost short-term credit loans because, despite increased regulation, they are remain expensive ways to borrow.
There's more detail on alternatives to payday loans in our dedicated guide.
How much are we borrowing informally?
Getting data on the amount of informal lending in the UK is tricky precisely because it's informal and unregulated.
We know that parents have been helping their children with home deposits for years, but we also have some figures from various sources showing that informal lending remains a significant form of borrowing for some.
The Financial Lives 2020 survey published by the Financial Conduct Authority (FCA) found that:
- 10% of people (5.1 million) had taken a loan from family or friends in the previous 12 months, an increase of the 7% seen in 2017
- 18% of 18-34 year-olds and 12% of 35-54 year-olds had taken such a loan, although the figure was just 2% for those aged 55+
The survey, which covered the period during and after the first coronavirus lockdown in 2020, also found that 19% (9.7 million) expected to borrow money from family or friends in the future.
Again, younger age groups were more likely, with 42% of 18-24 year-olds suggesting they might take such a route for credit.
We've also got more recent data from Shawbrook who undertook a survey in February 2022 that found:
- 77% would only borrow from family and friends in an emergency
- 30% would find asking to borrow money an awkward experience
- 45% regretted borrowing from a loved one and 62% of those found it uncomfortable and it caused problems
So, there is a high level of regret associated with borrowing from family or friends and many believe it would be an awkward experience.
It could be that implementing some of the strategies we've discussed in this guide could help avoid the awkwardness, but it might also be worth looking into other forms of borrowing before resorting to asking family and friends for help.
Summary: Should you borrow from family or friends?
Borrowing money from family and friends can be fraught with difficulty and it's something that is viewed as a last resort by many.
With a written agreement in place, it can be a useful form of borrowing, but it's important to make sure both parties know exactly what the terms and conditions are.
It's also worth looking at whether the need to borrow from family and friends is masking a bigger debt problem and we've got some guides to help address that.
Finally, if the situation has got to the point where debt collection agencies are involved, here's more about what to do when threatened by bailiff action.