Can’t repay your loan to friends and family? Here’s What To Do – Forbes Advisor INDIA

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Borrowing a loan from friends and family is very attractive to many for a number of reasons. These include, but are not limited to, non-compliance with formal loan requirements, poor credit ratings and a significant amount of debt that has already accumulated.

Such financial constraints can force people to reach out to their friends and family for funds. The capital thus secured is attractive for a number of reasons, some of which are listed below.

What makes borrowing from friends and family attractive?

1. Ensure easy receipt of funds:

Unlike formal loan applications from financial institutions and government schemes, loans provided by people close to individuals are easier to obtain. This is due to several reasons, including the preexisting relationship between the two people.

The absence of the need to apply for a loan, along with the absence of the need to verify the borrower’s behavior also simplifies the process. Provided both parties agree on the loan amount and repayment schedule, these borrowed funds are relatively easy to obtain.

2. Desirable interest rates:

Due to the nature of the relationship between the lender and the borrower, borrowers can take advantage of low interest rates, if they do not exist at all. This means that borrowers have the opportunity to save money that they would otherwise have to pay.

3. Lack of detailed paperwork:

Formal loans usually require a variety of documents that borrowers must provide in order to approve the loan. In the case of informal loans secured from friends or relatives, you can avoid the need to provide documents and go through the “know your customer” (KYC) verification process.

These documents include application forms and various forms of identification. Except for a single loan agreement, most lenders will not require borrowers to jump through loopholes to get funds. In this way, borrowers can save time, effort and money.

4. Flexible repayment method:

Loans from friends and family allow borrowers to use the repayment schedule that suits them and their capabilities best. More often than not, they have the ability to spread their repayment schedules over vast periods of time if they so require. Borrowers can also make short recurring payments every few months instead of making them monthly.

Why should you rethink borrowing from friends and family?

While the aforementioned points indicate why people are drawn to them, they should also consider the negative aspects of such loans.

1. Unclear conditions caused by an unofficial loan:

Due to the existing bond that the lender and borrower have in these scenarios, the act of granting a loan may not always be handled with the proper level of formality. When such a loan is provided in a hurry, lenders may even agree and provide the specified amount without any written agreements that stipulate the terms of the agreement.

The lack of such written documentation may lead to complications in the future, including the lack of confirmation of the amount of funds provided and the conditions attached in case of any dispute.

2. Feeling awkward:

When asking loved ones for financial assistance, such as loans, people run the risk of feeling uncomfortable around them. These feelings can continue for a long time after the loan is repaid. Borrowed money continues to hang over the borrower like a black cloud that can create a sense of awkwardness every time the borrower interacts with the lender.

3. Lack of an established repayment plan:

Official financial lending institutions such as banks provide borrowers with a repayment plan in which they define repayment schedules. They usually break down the entire amount due into smaller portions that are payable monthly over a period of time. Borrowers are free to follow this plan or can pay the entire amount due in one go.

However, banks cannot insist that lenders make a one-time repayment of the loan for the entire amount. Lenders who are friends or family of the borrower are not subject to these rules. They can demand repayment of the entire loan on a specific date for any number of reasons, not limited to financial emergencies. Such scenarios increase the uncertainty associated with payments on these loans.

4. Relationships can be damaged:

If loans from a family member or friend cannot be repaid, borrowers run the risk of breaking their relationship with the lenders. The relationship has ceased to be the same due to feelings of distrust, remorse and anger.

What to do before borrowing from friends and family?

In the event that such borrowing is unavoidable, the following recommendations should be considered.

1. Honesty is a must:

Before borrowing from a loved one, borrowers should be honest about their finances. Such loans should be taken as seriously as bank loans. Borrowers must provide their lenders with documents detailing their current finances and proof of their solvency in order to be eligible for such borrowing.

They also need to inform lenders where they plan to spend this money so that lenders feel that their money will be spent wisely and for the right reasons. By providing this information to lenders, they may be more inclined to provide loans to borrowers.

2. Terms of repayment:

The agreed loan amount, repayment plan and interest rate, if applicable, must be clearly communicated to both parties.

3. Draw up a legal loan agreement:

Instead of simply discussing the terms of repayment, it is imperative that you draft a legally binding document of the loan. This document must be signed by both the lender and the borrower to avoid any future disputes. Both parties must have copies of the same document and a witness must be present at the time of signing the document.

4. Automation of loan repayment:

Based on the agreed loan repayment plan and the agreed terms before which each payment must be made, they can be automated. This allows borrowers to avoid missing payments and provides lenders with the same respect as banks. In India, the National Automated Clearing House is used by official financial institutions to ensure that loans are repaid on time.

5. Always have a backup plan:

In the event that borrowers are unable to repay a loan from a friend or family member, they should always have a Plan B. This can be in the form of an offer to pay late fees in the event that payments are not made on time. Otherwise, borrowers must be willing to provide collateral to their lenders to show how serious they are about meeting their repayment requirements.

How to avoid default on a loan from friends and family?

In the event that individuals are unable to provide their creditors with the amount due to them, they should consider the following actions.

1. Refrain from evading creditors:

Regardless of whether borrowers may or may not be able to make payments, it is vital that they do not shy away from their lenders. The lenders in this scenario are not just unknown organizations that only provide fiscal services, but the borrowers also have close personal relationships with them. By avoiding lenders and cutting off any contact with them, borrowers run the risk of ruining their relationship and can also create a bad reputation for themselves.

2. Recognize the duality of the role of the lender:

Borrowers should be aware that their loved one is also a lender. They should not take advantage of their close ties and assume that they might be careless when it comes to repaying the loan.

3. Be honest:

In the event that borrowers are unable to repay loans taken from their friends or family members, they should inform them of these facts as soon as they realize it. Explain why you, as a borrower, cannot afford to pay off the debt. This could mean showing lenders a ledger with your daily expenses and inevitable payments. This could convince lenders that the borrower is honest and understands the importance of repayment.

4. Develop new repayment plans:

In the event that borrowers cannot meet their pre-existing payment plans, they should discuss the possibility of new plans with their lenders. In the event that these lenders demand repayment of the loan in one go, and the borrowers cannot afford to repay them, the borrowers should be willing to offer something in exchange for their debt. This can be in the form of goods they own or offering them services that they can provide.

5. Avoid additional costs:

Until borrowers pay their premiums in full, they should refrain from investing in secondary expenses that do not really matter. Such spending can be annoying to lenders, who may notice that their money is not being returned, but instead spent on things that can be bought later.

6. Make debt repayment a priority:

Ideally, borrowers should keep 2-month loan payments in their bank accounts. This should be reserved for their lender and they should prioritize these payments.

Why shouldn’t friends or family offer loans?

Potential borrowers should be aware of the restrictions they place on lenders when using these loans. Such loans are not always particularly good fiscal decisions made by lenders as they present the following problems.

1. Lack of interest:

Unlike loans from official credit institutions, these lines of credit most often do not earn any interest. This means that lenders are not making any additional money by lending out their existing capital.

2. Funds may be required by the creditors themselves:

Unless lenders have a mostly unlimited supply of money, they need to be careful with the amount of money they lend to their friends or family members. They may well run into scenarios where they themselves need funds but have passed them on and cannot access them immediately.

3. Borrowers can request more:

By linking closely with the funds to borrow, lenders run the risk of creating scenarios in which they return with requests for additional amounts of money. Borrowers may even go so far as to recommend lenders to others who are equally close to the lender. Consequently, lenders may end up playing the role of a bank, which they might not want to do.

4. Allow bad habits:

By providing borrowers with an easy way out of their financial problems, lenders run the risk of creating and exploiting bad financial models among their friends and family. It is important that they know what the borrowed funds are being spent on and make sure they do not promote bad habits such as gambling or addictions.

5. Creates uncomfortable situations:

Lenders can get into awkward situations asking for their money back. These scenarios require tact, patience, and the ability to remain cool and collected, especially when dealing with loved ones.

Bottom line

Any borrowing should be done after considering several of the above points. Borrowers are advised to borrow only what is of prime importance and not a cent more. They should also remember that adding money to a pre-existing personal relationship can be irreversible and should be handled with care.

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