With a plethora of lenders available in the market, most people refrain taking a loan from their family and friends in today’s time. This is mostly because mixing money with family or friendship can sour the relationship, even if all due caution is exercised.
However, many times, we aren’t left with many options and are forced to turn to our friends or family members for a loan. This could be because of ineligibility to take a loan from a bank or the urgency of the situation. If you’re also caught in such a situation, make sure you know exactly what you are getting into, and what are the things you need to keep into mind before borrowing money from loved ones.
Why (and how to) ask a friend or family member for money?
There are several reasons why you may end up borrowing money from a close friend or family member; you may be unqualified to apply for a loan, your credit score could be too low, or you could be under massive debt already. If you’re in a financially tight situation, you might want to turn to friends and family for support. However, be sure that you consider this like any other loan and can return the amount as per decided schedule. If you are unable to repay the amount, it may result in misunderstandings and can cause resentment between you and your loved one.
Once you have decided to approach a friend or family member, the question is, how do you go about it? To begin with, be honest about your situation, how much amount you require, how you intend to use it, and when will you be able to return it. Do not borrow more than you can repay and do not promise an unrealistic repayment schedule. Even if you have known your lender for all their life, it is best to make things official by drafting a loan agreement contract which contains all the necessary terms and conditions signed and agreed by both parties. This way, both the lender, as well as the borrower, would be protected in case of any disagreement in the future.
Pros of Borrowing Money from Friends or Family
- Instant access to funds
Your loved ones will not make you wait for days to approve your loan application or conduct verification to your address to grant you the loan. In most cases, if you agree upon the amount and repayment schedule, they will give you the loan as soon as possible, which means you can get instant access to funds.
- Repayment can be flexible
Unlike traditional lenders, like banks and financial institutions, you can create a flexible repayment schedule with your friends or family members. This means that you can spread the repayment schedule across several months, or even years, if needed. Furthermore, you can choose to repay the amount in small amounts periodically every few months, thus, removing the need to pay monthly EMIs as well.
- No or low rate of interest
Friends and family members might choose to lend you money without imposing any interest on the same. Even if you do agree on an interest rate, it is likely to be lower than the market rate, which means you end up saving money by paying a lower (or zero) interest.
- Devoid of formalities or prolonged processes
As mentioned earlier, borrowing from a friend or family member will provide you instant access to funds. However, that’s not the only benefit; you will also be saved from the hassle of filling long application forms, providing documents, undergoing KYC verification, or other time-consuming formalities. If the person you are borrowing money from agrees to lend it to you, other than drafting a loan agreement, there usually is no other sort of official process you need to take care of. Thus, borrowing from a loved one saves you time, money and effort.
Cons of Borrowing Money from Friends or Family
- Unofficial credit
When borrowing from friends or family, people usually do not take the loan with as much seriousness as that of other official lenders, like banks and financial companies. Furthermore, if the loan is given in a hurry, without signing an agreement and only on mutual terms, it may result in complications in the future. Both the parties will have no way to prove the loan amount and the terms of the loan, in case of any future disagreements, which is not the case when official loans are taken.
If you have taken some money from your friends or family, it may become a source of discomfort or embarrassment, until the amount has been repaid. Sometimes, this discomfort may even continue after you repay the amount. This is because the money which you owe them can create a sense of indebtedness every time you meet them at any social gatherings or meetings, which can result in an unsaid sense of uneasiness in your relationship.
- Might be asked to repay the entire amount anytime
When you borrow from a bank or a financial institute, you agree upon a repayment schedule, that usually lasts a few months or years. This helps ease the financial strain of the loan by breaking it into smaller monthly EMIs, and while you can foreclose the loan before the original timeline, the bank cannot ask you to repay the entire amount prematurely in a single go. This is not the case when you borrow from friends or family, as they may ask you to return the loan due to an emergency at their end. This increases the uncertainty over the repayment as you may be asked to repay a huge amount, or a part of it, at any given time.
- Might spoil the relationship forever
Conventional wisdom says that brining money into even the most secure and trusted relationship usually plays a spoilsport. As stated earlier, a loan might be a source of awkwardness or discomfort between you and your lender, and this might not go even after you repay the entire amount. However, in the event, you are unable to repay the amount, you might spoil the relationship forever, as it is usually difficult for people to look past the same.
How Much Money can you Loan a Family Member or Friend?
If you are gifting money to a friend or family member and its value is below INR 50,000, it is not taxable. However, if the value of the gift increases to more than INR 50,000 in a single financial year, it would be taxable.
These terms are different when it comes to a loan. Up until a few years ago, loans taken from family and friends were taxable. However, today, loans from loved ones are no longer taxed. This means that if you borrow money intending to pay it back and consider it a loan, it will not be taxed to the borrower or lender.
Another thing to keep in mind is the provision of interest on the lent amount. This is due to the fact that the lender would then have to pay the tax for the interest which they earn. The liability of a borrower to pay the tax against the interest charged varies with different scenarios. For instance, if the loan amount is borrowed for the purchase of a home, the loan amount would be eligible for the deduction of taxes under Section 24C of ITA. However, in such a case, you would need to provide all the relevant documents to the assessing officer, which justify how the loan amount has been utilized for the purchase of the home or property. If you borrow any amount for any personal use, you would not be getting any tax benefits.
Remember, any form of a non-institutional loan, to or from a private individual, including your family and friends, is not eligible for the deduction of taxes under ITA’s Section 80C. This means that you would be unable to claim the deduction of taxes on the principal amount borrowed. Thus, you can loan any amount to your family member, but you will be liable to pay taxes on the interest you receive on the same.
Things to Keep in Mind While Borrowing Money From Friends and Family
- Be honest
Banks have a stringent eligibility and verification process in place to establish the creditworthiness of an individual. You should exhibit the same honesty and seriousness when you approach a friend or a family member for a loan. An honest conversation about your financial needs, ability to repay, and usage of the amount will evoke a much better response from your loved ones. This must also include all the details about the required loan amount, your proposal of the repayment schedule and the interest which you can pay.
- Give detailed terms for repayment
It is natural for you to be a little laid back while borrowing from your loved ones. You are likely to assume that they will give you the time needed to repay the loan whenever you are comfortable and might refrain from committing the repayment. However, this is likely to reduce confidence and trust. Thus, break down all the details about how long it would take for you to repay the amount and if you’d like to do it in small installment or a lump-sum. If you are signing a loan agreement, it is best to include these terms in the same.
- Draft a legal loan agreement
All the details of the loan amount and repayment should not be verbally communicated to your lender. Each of these details needs to be drafted in a legal agreement and needs to be signed by both parties to avoid any disputes in the future. Both the lender, as well as the borrower, must have a copy of this agreement and witnesses should also sign it.
- Automate the EMIs, if any
If you have agreed to make monthly, or quarterly, or even annual, payments, make sure you automate them to avoid any delay. If you get a loan from any bank or financial lender, they too make you sign the NACH (National Automated Clearing House) form to ensure regular payments are made on time. You must follow the same habit when borrowing from close friends and family too.
- Have a Plan B for repayment
Due to some unforeseen situations, if you are not able to repay the borrowed amount within the agreed-upon time frame, make sure that you have a backup plan in place. You can offer the lender a late fee in case you miss out on repaying the amount within the time agreed. If you want the lender to believe how serious you are about repaying the loan, you can even offer collateral to which they can hold on to until you repay the borrowed sum.
All matters of money must be handled in a very professional and disciplined manner to avoid any negative repercussions in the future. This holds true even when the dealing is with your family or friends. In fact, when lending or borrowing money from family or friends, it is all the more critical to handle the entire financial transaction with as much clarity as possible. That’s why most people avoid risk spoiling their cordial relations and take a personal loan instead.
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