Common reasons for needing a loan are buying a first home, a car or large medical expense. Sometimes it’s just some extra cash for that unexpected appliance repair bill. Some of us will take out a bank personal loan or leverage credit card spending limits. However, there are distinct advantages of friends and family personal loans worth noting.
Here are the top eight reasons why a friend or family member may be the best bank for your loan:
- Get a small loan. Most banks aren’t willing to offer small loan amounts. If you just need $200 for that car repair bill, the bank is not an option. If you are looking for at least $2000, websites like Prosper may be a good solution.
- Fast access to cash. Personal loans from a bank may take days for approval or disbursement. When you need money right away, friends and family are the go-to.
- No credit check needed. For many borrowers, especially those that are younger and still establishing credit, the credit check disqualifies them. At best, approval may come with a high interest rate. (Learn more about the disadvantages of usurious payday loans.) Borrowing from friends or family allows you to bypass the credit check process and no one has to see your FICO credit score!
- No collateral required. Collateral is an asset (such as property or a car) that you offer up as a guarantee that you will repay your loan. If you default on the loan, the collateral asset becomes the property of the lender. This is known as a secured loan. (Learn more about collateral for loans.)
- Flexible terms. You can negotiate with the borrower how much you will pay back and by when. Weekly payments? Monthly? Lump sum all due on a certain date when you get your annual bonus? Lending money between friends and family offers up flexibility that banks and credit cards can’t match.
- No to low interest rate. In many cases, due to the personal relationship, the lender will not charge any interest rate to the borrower. This means that if you borrow $1000, you will pay back $1000 rather than $1247.95 (based on equal monthly installments of $34.67 at a 15% interest rate over three years.) Now compare that to credit card payments at a 29% interest over the same term – that would be $1508.61 paid back against the $1000 loan! In some cases, however, you WILL want to pay a minimum level of interest to avoid taxation status. Which takes us to the next point…
- Maintain non-gift status. This is very important, especially for home buyers and others who may be requesting loans of $15,000 or more. Monetary gifts over $15,000 may be taxable which means the giftee would have to claim the gift on their personal taxes. So, based on your tax bracket rate, you may have to fork over quite a bit of that gift! By providing the funds as a documented loan and with a minimum interest rate paid by the borrower, tax consequences can be avoided. View our sample personal loan documentation so that you can establish and document a personal loan.
- Learn fiscal responsibility and build trust. Documenting a loan between friends and family members (especially between parents and their children) can train teens and young adults to not only be responsible with their money but also instill the good habit of fulfilling obligations. Read more about ways parents can teach fiscal responsibility to their children through small loans.
While these are all terrific advantages for a friends and family personal loan, be sure to check out some of the disadvantages of friends and family personal loans.