Personal finance: When friends, family and finances mix

Aug 8, 2011

The current credit crunch has made it harder for people to get loans from a bank. Gone are the days when you could walk into your local bank branch, flash your credit score and walk out with a loan. So many are turning to their friends and family for help...but is that a good idea?

To lend, or not to lend

When Pete and Michelle Baker wanted to buy a new house, they needed money for a down payment. Their down payment was tied up in their old house, which they hadn't sold yet.

So they turned to Pete's parents for a $40,000 bridge loan. Pete says "it was definitely a hesitant conversation" at first when he brought up the idea to his dad, Frank.

"I mean he [Frank] is the one that brought up interest, he’s the one that brought up structuring payments, he’s the one that brought up writing out contracts and putting everything on paper. But then he didn’t insist on any of it when it came from him. It was definitely a handshake over a beer type thing."

In general, Frank Baker believes "it's always dangerous to loan money to relatives," and that "family’s just too valuable to risk on a disagreement over a loan." But when it came to his son, he took the risk. Frank says he and his wife don't need the money to retire, so it will be "great" if they get it back, but "it’s not worth losing a relationship over."

When a "loan" becomes a "gift" - a cautionary tale

Stephanie Landragan used to loan money the old fashioned way: with a handshake, or by scribbling a note on a kitchen napkin. Once Landragan, an instructor with UCLA extension, loaned a friend of hers $5,000 so the friend could make rent. Six months went by and the friend never brought up repayment.

"Then the seventh month she took a vacation to Europe, which I think was on my money! Which was really hurtful and also really kind of a wakeup call."

The "friendly" loan gets formalized

What if your best friend or cousin asks you for a loan, and you have the money, but you actually need it back?

Turns out there’s a growing sector of peer-to-peer lending websites. For a fee, you can use the sites to set up a formal loan with your friend or a family member. Some of the sites even let you track repayments on line. There are about 10 of these social lending websites.

Michael Kovacs founded LendingKarma three years ago. To date, 10,000 people have used the service, and the site recently hit a half billion dollars in loans. Kovacs says, unlike a bank, LendingKarma lets borrowers and lenders set their own terms for the loan:

"The lender usually gets a better interest rate than if they kept their money in a savings account. And a borrow certainly gets a better rate...than what they would from a bank. You know a used car loan at 14% - someone in their family can lend them that same car loan at 8% and that’s a great return."

Kovacs says the most popular loans on the site are for cars, followed closely by real estate loans.