Borrowing money from family and friends

Most of us have needed to borrow some money from time to time, whether it is for a major purchase such as a deposit on that first home, or just to tide us over during difficult times. Today it is not quite the same world of easy credit that it was 10 years ago, but there are still plenty of decent loans out there at low interest rates for those who have a reasonable credit rating. However, ask and financial adviser, and they will tell you that the most cost-effective way to raise emergency funds is to borrow money from family and friends.

That’s not always an easy thing to do, and we’ve all seen and heard of instances when it has ended in disputes and people falling out. This makes many of us reluctant to ask those closest to us for help, which is a shame, as provided you go about it the right way, it really is the most practical way to raise that much needed cash. Here are three factors to keep in mind.

1) Communication and transparency

It can be a little embarrassing to ask, or indeed to be asked, we get that. But unless you can sit down and talk through what you need, why you need it and how you are going to repay it, then don’t even start. The worst thing is to quickly ask to borrow some money, railroad your friend or relative into handing it over and leave the repayment hanging in the air.

As the borrower, you need to set out exactly how much you need, and then talk about how and when you will repay it. The lender similarly needs to think about whether they can lend that amount comfortably, and whether those repayment terms are acceptable.

2) Formalise the informal

Borrowing in this way is described as an informal loan, but you should still memorialise the agreement in writing with a loan agreement. The lender might be reluctant to ask for such a document, fearing it looks like they don’t trust you, but if you insist on it as the borrower, it demonstrates that you are serious about paying the money back. It also means that everything you have agreed is absolutely crystal clear – so there is far less likelihood of any misunderstandings or disputes further down the line.

3) Consider the tax implications

Most people don’t realise that there are potential tax implications attached to an informal loan. If you have agreed an interest rate, the lender needs to inform HMRC, as the interest might be liable for taxation. Of course, if the loan is interest-free, then there is no need for anyone to pay tax.

There is also the potential for exposure to inheritance tax. It might sound morbid, but if the loan is from an elderly relative, you need to keep this in mind. Any sum of money up to £325,000 that is a gift (not a loan) is free from inheritance tax, provided the person handing over the money lives at least seven years after making the payment.