When Grandpa Michael started his business several decades ago, he borrowed money from Uncle George. Business went well, but the relationship soured. In fact, the relationship ended after years of fighting over money and just how much Uncle George should earn. I learned from observing this experience that family and business don’t always mix. As a result, I’ve often asked myself, “Self, should family ever be involved in my finances?” My general reaction is to say no. However, there is a bigger picture to consider. In certain situations, my answer changes to, “Well, yes.”
In the last few years, the Internet has seen the rise of social lending. For those of you unfamiliar with social lending, it’s when you receive a loan from someone other than a bank. So every time you ask your roommate to lend you $20 so you can go to that concert, you just participated in social lending. Sites such as LendingClub.com and PertuityDirect.com have formalized the process and allow nearly anyone to participate. Another big hitter in this market is VirginMoney.com. Sir Richard started his empire through a loan from his aunt. He now wants to help other individuals secure a loan from family or friends in order to start a business, pay off some debt, go to school, or even pay for their home.
So why use social lending, especially if the money comes from family, instead of obtaining a traditional loan from a brick and mortar bank?
- Maybe you don’t credit qualify. We have all made mistakes and that might reflect on your credit report. Social lending provides an opportunity that might not otherwise exist.
- You may find a better rate. Certain social lending sites, such as LendingClub, set the interest rate on each loan based on the credit history of each loan applicant. However, VirginMoney allows you to negotiate the rate yourself if you know the person(s) funding the loan. So if a bank offers you 10% on a personal loan, Grandpa Michael might agree to 8% (he knows you’re good for it).
- Family wealth, or money passed on through the generations in your family, is difficult to maintain when you pay so much of it to financial institutions. Most of us want to leave assets or money to our children (whether that be funds to be used specifically for college tuition or a first home purchase or just good old hard cash). Either way, we cannot pass on what we have given to banks. By borrowing from family, you keep it in the family and encourage the growth of family wealth.
But what about mixing family and finances? Sure, it sounds like a good idea to keep money in the family, but what if you risk repeating what happened with Uncle George? This part is tricky. How you answer that question for yourself depends a lot on your relationship with family members. Though, I do have a few simple suggestions. First, keep the term of the loan short (2-4 years) if you believe problems may arise. Grandpa Michael and Uncle George were business partners for 30 years. Second, if you use a social lending site, then your payments are set, scheduled, and can be automated. Meaning, Dad doesn’t have to wonder when the payment is coming. And last, do not borrow money without a legitimate reason. This may seem obvious but consider the current economic condition and how we arrived here. There is a difference between needing a new car because you have outgrown the old one and needing a 2010 Escalade. If you overextend yourself with family, they may or may not be more forgiving than a bank.
In short, borrowing from family via a formalized process helps you receive the financing you need and has the added benefit of growing family wealth. Though as with any loan, ask yourself this question first, “Do you really need the money and can you afford the payments without a high risk of overextending yourself?”
So have you or would you borrow a substantial sum of money from family? Leave your comments below.
(This post was featured in the Carnival of Personal Finance – History of College Footbal Edition)