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Personal Loans

Personal Loans – Lending Money Or Borrowing Money From Friends, Family & Private Lenders

Borrowing money is getting more difficult with rising interest rates and growing economic instability. It is harder to meet the qualifications for personal loans or mortgages. It’s tempting to consider turning to family or friends when you can’t qualify for credit.

Alternatively, a friend or relative might ask you for a loan or to be a co-signer. While these are everyday situations, they’re not always in your best interests. Here, we’ll explore why lending money to family and friends may not be the right thing to do.

Lending to Family and Friends

Someone in your circle of friends and family may approach you for a personal loan. Or, they may ask you to co-sign a loan or mortgage for them. They may do this for several reasons. The most common ones are:

  • They have a limited credit history.
  • Their credit rating is poor, so they can’t get a loan or mortgage without a cosigner.
  • They don’t have enough income from the lender’s point of view to make the loan payments.
  • The lender can’t verify their income because they get paid in cash.
  • Their history with their employer is too short because they just started their job.
  • It’s easier to borrow money from you than from a lending institution.

These reasons make sense from the borrower’s point of view, but what about you? Before you consider loaning money to family or friends, consider how the loan will impact you. Lending money to friends or family can affect three significant areas of your life. It can impact your finances, make you liable for someone else’s debt, and hurt your relationship.

How personal loans can impact your finances

Wanting to help a family member or friend is natural. You care about the people in your life and want to support them. However, doing so can put you in a financial bind. Consider its impact on your immediate or future goals and your cash flow.

Your finances

Lending money can leave you short of cash for goals you need or want to accomplish. You might use your emergency fund, retirement savings or equity in your home to fund the loan. The money will be gone if the other person doesn’t pay you back, leaving you in a difficult situation. Before lending money, ask yourself if you can afford to lose it.

If you co-sign a loan or mortgage, the lender often makes a complete credit application for you and the other borrower. You will be responsible for payments if the other person doesn’t pay. Paying for someone else’s debt could strain your budget and relationship.

Co-signing loans or mortgages can make borrowing challenging until the loan is paid off. The debt may appear on your credit report. Your report will show you have a payment owing for that debt. Your lender will add the payment when calculating how much you can afford to borrow. As a result, you may not qualify for additional credit because of that payment, even though the other person is making the payments.

Late or missed payments will affect your credit rating, possibly resulting in a poor credit score. If you cosign a loan, make sure you get copies of any paperwork. That way, you can ensure payments are made on time and be notified if there’s a problem.

Your liability

If you lend your money to a friend or relative, you’re not liable for the debt, but you could lose that money. One way to protect yourself is to have the borrower sign a promissory note outlining the terms and conditions of the loan.

However, co-signing a loan or mortgage can lead to legal or tax liabilities. Two common problems are that you’ll be liable to make payments if the other person does not, and you could incur tax implications.

If a friend or family member asks you to be a joint borrower or co-signer, it’ll be your responsibility to keep the payments up to date if the other person doesn’t. Failing to make payments can result in a poor credit rating for both of you, making it difficult for you to borrow in the future. Additionally, if you secure the loan with an asset of yours, the lender could seize the asset if the loan falls into arrears.

Taxation is another issue to consider when lending money to family or friends. If, for example, you lend money to your adult child to buy a home, they may put you on title. Adding you to the property title can result in a situation where you are considered part of a “bare trust.” The government now requires most bare trusts to file an annual T3 and, in some cases, a Schedule 15. The additional reporting may add to your accounting fees and tax burden.

If the asset is sold, you might face other tax implications, such as capital gains. It’s best to talk to a tax expert before proceeding to avoid unexpected complications.

Your relationship

Lending money to friends or relatives can sour your relationship. Lenders and borrowers sometimes have different expectations of when payments are due or if the loan must be repaid. A promissory note detailing the loan terms can help avoid misunderstandings, but you may need to take the other person to court to enforce it. Although you and the borrower may have had good intentions, this situation can end poorly.

When someone asks you for a loan or to co-sign a loan, it typically means they don’t qualify on their own. Lenders consider the person to be a poor risk. Before lending money, be honest with yourself. Ask if the borrower is likely to repay you. If the answer is “probably not” or “no,” you can direct them to other sources.

Other places they may be able to borrow are:

  • Cash advances from a credit card. They can access available credit by withdrawing it from their card.
  • Payday loans and fast cash are smaller short-term loans that carry extremely high interest rates, which can leave borrowers in a never-ending debt cycle.
  • Private lenders offer loans to non-traditional borrowers, typically for larger sums.
  • Private mortgage lenders are individuals or companies who lend to borrowers with poor credit or income that traditional lenders can’t verify.

Interest rates for all these sources can be extremely high, putting your family member or friend in a more difficult position. However, it’s in your best interests to protect yourself financially and to preserve your relationship. Lending money to people who don’t repay you can lead to serious financial consequences, including putting you in a position where you can’t pay your bills.

Getting Help With Your Debt

If you’re in a situation where your debt is overwhelming, help is available. Owing more than you can manage is stressful and can negatively impact your quality of life. At Adamson & Associates, we understand bad debt can happen to good people.

For a free consultation, contact us online or at 1-877-930-1934. Our Licensed Insolvency Trustees will work with you to find the best solution to get you out of debt and back on the road to financial freedom.

John Adamson, Licensed Insolvency Trustee Ontario

John Adamson, CPA, CMA

John is a Licensed Insolvency Trustee (1994), a Chartered Insolvency and Restructuring Professional (CIRP – 1994), and a Chartered Professional Accountant with a Certified Management Accounting designation (CPA, CMA – 1992). His experience includes more than 25 years of helping individuals, small businesses, their owners and even lenders, find solutions to their debt problems.

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