What Is a Friendly Loan?

When cash is borrowed from a family member or a friend with the understanding that it would be repaid, this type of loan is referred to as a “friendly loan.” A friendly loan is typically an unwritten financial arrangement. In this scenario, you would not have to go through the hassle of applying for a loan from a bank or credit union because you would be borrowing cash straight from another person.

There are no standard guidelines for how to handle a friendly loan because these types of transactions typically occur outside of the traditional banking system. Depending on the circumstances, parties may or may not put their agreements in writing and may or may not specify the terms of repayment.

However, the Consumer Financial Protection Bureau suggests that the lender and recipients must have open communication regarding the loan, the repayment terms, and the intended use of the funds.

How Does a Friendly Loan Work?

The “lender” of a friendly loan may be more accommodating in terms of loan quantity and repayment schedule than a traditional financial institution. In addition, there is usually no need to verify credit, and the interest rate on the loan may be extremely cheap if not nothing. In the long term, that could help you save quite a bit of cash.

Let’s imagine you would like to rent your first house after graduating from college. Although you are employed and have the means to pay for rent, you are unable to come up with the large security deposit. To cover this security deposit, you can approach your family for a friendly loan and agree to pay them back in monthly installments.

Lenders count on borrowers keeping their part of a friendly loan, but problems arise when borrowers don’t. Problems may arise due to the unpredictability and lack of documentation surrounding the repayment of a friendly loan. As a result, it may be challenging to recuperate payment, and the relationship may deteriorate.

So let’s look at another illustration. Now imagine that your sibling is in need of a car. They couldn’t get a car loan, so they’re turning to you for help. Maybe you’re in the same boat, and you don’t have the money on hand, but a car loan is still an option. To help you pay off the auto loan, your sibling has offered to send you a monthly payment. 

However, after a few months of working together, they quit paying you and began ignoring your phone calls. You’ll need to take responsibility for the loan’s repayment on your own, which could strain your relationship.

Moreover, you can’t insist on getting your sister to make regular payments toward the loan if you didn’t put the terms of the loan in writing and get a signed agreement from them.

What Are Friendly Loan Agreements?

Treating a friendly loan seriously and putting it in writing with a friendly loan agreement can increase the likelihood of a positive experience for both the lender and the borrower.

Document all you can about the loan: the interest rate, the repayment schedule, and the total amount you’ll owe.

You should also have an open discussion about what is expected of each party when the friendly loan is made. Because you and your loved one may have different expectations, it’s important to make sure you’re on the same page before making any commitments.

Issues that need to be discussed include:

• What happens if you run into problems repaying the loan in the allotted time frame?
• When is there going to be a review of the money situation?
• Do you intend to return for additional funding, or is this a one-time deal?

The drafting of any loan agreement, even a friendly one, requires careful consideration and should be done with the advice of legal counsel. When trying to get your money back from a borrower, having a well-written agreement on hand will make things much easier in the long run.

Are Friendly Loan Agreements Legally Recognized?

It’s a common misunderstanding that lending money to friends and family while charging interest constitutes illegal money lending. True to its name, a friendly loan contract is a legally binding agreement between a lender and a borrower. Even if the borrower defaults on the loan, the lender can still collect legal interest payments under the law.

Friendly Loans: Pros and Cons

Take a look at the following list of pros and cons before deciding whether or not to borrow money from a friend.

Pros

• There is no requirement for a credit check. A friend or family member is unlikely to examine your credit history before lending you money, as would be the case with a bank.

• Potentially attractive interest rates. Since no third-party lender is engaged in a friendly loan, the interest rate is typically very low.

• Flexible repayment agreements. When considering a friendly loan, the relationship between the two parties is crucial. If you ask a friend for money and they trust you, they may give you a loan with loose repayment terms, such as asking you to pay back whatever you can afford rather than a certain sum on a set day of the month.

Cons

• The inability to repay may strain friendships. Negative feelings, less communication, and even anger could develop if a loan is not repaid in a timely manner.

• Without a documented contract, parties have no legal solution. Without a written agreement, you may have no recourse to reclaim any funds you loan to a friend who fails to repay the loan.

• Possible future use of funds by lenders. If your lender was counting on getting their money back by a certain date and you don’t pay it back, it could put them in a tough financial position. However, borrowing from your own resources means that you won’t have access to those funds in the event of an emergency.

What to Consider Before Lending Money to Friends or Family?

To put it simply, a “friendly loan” is a loan made between friends or acquaintances rather than a formal bank or credit union.  The lender and borrower of a friendly loan may or may not have a formal written agreement. Even without these elements, the agreement has the same force and effect as a legal and financial one.

• In order to legally establish the terms of the friendly loan, both parties should sign a Friendly Loan Agreement. Some people might be hesitant to put a loan of money to a friend or family member in writing for fear of “offending” the borrowers or damaging their ties, even if they believe that their friend or family member will repay the money as promised. When things go south with a friendly loan, it might be hard to prove your case in court.
  
  The first thing you should do is talk to a lawyer about having them create a friendly loan agreement for you. Bank in slips or transaction proof, as well as informal correspondence e.g. emails and texts to negotiate and arrange the loan and repayment terms, should be documented and preserved appropriately in case legal proceedings are necessary.

• Avoid charging extremely high rates of interest on friendly loans. As was previously noted, law enforcement may become involved if the interest rate on a friendly loan was excessive. Keep in mind that in the case of a friendly loan, the lender is permitted to charge an interest rate that is “justifiable and reasonable,” provided that it is not extortionate, excessive, or unreasonable.

• Establish a specific time frame for paying back the loan. For the goal of recovering the loan, which may be in default by the borrower in the future, a precise repayment term indicated in the agreement is vitally important. The statute of limitations for collecting on debt is six years from the date of repayment. 
  
  To put it another way, a lender has six years from the date of repayment to file a lawsuit against a borrower who has not paid back the loan. Importantly, the lender cannot sue the borrower after the limitation period has run out.

Are Friendly Loans a Good Idea?

If both you and your friend or relative can agree on the terms of the loan, it could be beneficial to take out such a loan. Before getting into this kind of agreement, it’s best to be forthright and honest about what’s to be expected and the terms of repayment.

If the loan doesn’t work out, you’ll both be relieved to know that the terms are documented. The payment terms and amounts, as well as any available remedies, should be worked out in advance. This will ensure that all parties are on the same page and that no unpleasant surprises arise later on.

Final Thoughts

A friendly loan is a loan of money made between friends, relatives, or acquaintances with the understanding that the loaned money will be repaid.

In times of financial need, turning to friends and family for a helping hand is often the first option that comes to mind. It’s crucial to understand the basics of a friendly loan, as well as the pros and cons before you approach a friend or family member for money.