What Is a Friendly Loan?

Friendly Loans Explained

Couple sitting on sofa discussing money and budget
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A friendly loan often is a verbal agreement between family, friends, or acquaintances in which money is loaned with the expectation that it will be repaid.

When you’re short on cash and need additional financial help, your first thought may be to ask someone you know for a friendly loan. Before you consider asking someone for a friendly loan, it’s important to understand how it works, the pros and cons, and the ways to avoid any pitfalls.

Definition and Examples of a Friendly Loan

A friendly loan is usually an unwritten financial agreement in which money is borrowed from a friend or family member with the promise it will be paid back. With this type of loan, you may borrow the money directly from another individual without needing banks, credit unions, or other traditional lenders.

  • Alternate name: Intra-family loan (loans between family members)

Informal money agreements between family and friends are very common. In 2020, 53% of people in the U.S. borrowed or loaned money to a loved one, with the average borrower asking for $1,067, according to a survey by Lending Tree.

There are many reasons someone may find themselves in a financial pinch and need support from family or friends. For example, starting a business, making a down payment on a home, an unexpected expense, or help with staying afloat after a job loss are common reasons you may need extra money.

Friendly loans come with risks. The lender risks not recouping their funds, especially when there is no official documentation of the agreement. The borrower could also put their relationship with the lender at risk if they’re unable to pay back the loan.

How a Friendly Loan Works

One of the biggest advantages of a friendly loan is that your “lender” is likely to be more flexible about the amount and payment arrangements than a bank. Plus, there’s typically no credit check involved, and the loan could come with a very low interest rate, or even no interest rate at all. That could save you a lot of money in the long run.

For example, let’s say you just graduated college and want to rent your first apartment. While you have a job and income to pay the rent, you may be unable to cover the hefty upfront security deposit—usually worth the first and last month’s rent. You may ask your parents or guardians for help in the form of a friendly loan to cover this security deposit with the promise that you will repay them in monthly increments.

While the hope is that a friendly loan will stay true to its name, these could pose a risk to the lender. Since the terms and conditions of a friendy loan’s payback are often undocumented, they can prove to be unpredictable—and problematic. This can make recouping payment difficult, and the relationship could turn sour.

Here’s another example. Let’s say your sibling needs a new car. They didn't qualify for an auto loan, so they ask you for the money. Perhaps you don’t have the extra cash on hand either, but you are eligible for the car loan. You both agree that if you take out the car loan, your sibling will pay you the monthly payments to put toward the loan. After several months, however, they stop paying you and start avoiding your calls. You’re now on the hook for repaying the loan on your own, which could create a rift in your relationship. And if you didn't obtain a written agreement for this friendly loan, there’s no way to prove your sibling was supposed to pay you every month.

Types of Friendly Loans

Even though a friendly loan is often between family or friends, the process may not be as familiar as you think. In fact, there are different types of friendly loan arrangements.

The most common type of friendly loan is a simple agreement between a borrower and a lender. They verbally agree that the borrower will pay back what they borrow. This is essentially the same as an unsecured loan and does not require any collateral. These types of friendly loans are often based on a history of familiarity and trust between the borrower and the lender.

A friendly loan can also be a secured loan. That means the borrower has agreed to put up an asset such as a car or jewelry as collateral to secure the loan. If the borrower defaults and can’t repay the loan, the asset will be surrendered to the lender.

For better protection of both parties involved, friendly loans can include a written agreement, known as “a promissory note.” A promissory note is not a contract. Instead it is your written promise to repay the money you borrow. In simple terms, it acts as an IOU.

Even though a promissory note is not a contract, it is still a legally enforceable document.

To make sure the terms of the friendly loan are clear, both parties should sign the promissory note, and it should describe the basic details of the loan, such as:

  • Loan amount
  • Interest rate (if any)
  • Repayment schedule and deadline
  • Consequences if the loan is not repaid

Alternative to a Friendly Loan

Before extending a friendly loan to a family member, be aware that it’s not as simple as writing a check. To avoid tax implications, be sure any loan over $10,000 contains a signed written agreement, a fixed repayment schedule, and a minimum interest rate (applicable federal rates are updated monthly).

On the other hand, there is an alternative way to help out loved ones needing financial support. You could choose to give money to a family member or friend without the expectation of getting something of equal value in return, which is considered a gift.

If you loan money without charging interest and it exceeds $15,000 for the year, you may be required to pay the gift tax. In that case, you would be required to file Form 709 at tax time.

Gifting money may help prevent a strained relationship since the money isn’t required to be repaid. However, you must consider whether you may eventually need that money yourself.

Additionally, friendly loans given at no interest or an interest rate that the IRS considers too low must be reported as imputed interest on the lender's tax return.

Pros and Cons of a Friendly Loan

Pros
  • Flexible repayment arrangements

  • No credit check required

  • Favorable interest rates, if any

Cons
  • No legal recourse without a written agreement

  • Failure to repay could damage relationships

  • Lenders may need that money in the future

Pros Explained

  • Flexible repayment arrangements: Relationship history plays a huge part in friendly loans. If you are asking a friend for money and they consider you trustworthy, they may extend you a loan with flexible payment deadlines rather than the same day every month, or they may ask you to pay them back what you can, rather than a strict amount every month.
  • No credit check required: Unlike a financial institution, a friend or family member more than likely isn't going to check your credit score as a stipulation to giving you a loan.
  • Favorable interest rates, if any: Since no traditional lender is involved in a friendly loan, chances are your family or friends will charge little or no interest on the loan.

Cons Explained

  • No legal recourse without a written agreement: Making loans without a written agreement could leave you without a legal way to recover the money you lent to a friend if they don’t repay the loan.
  • Failure to repay could damage relationships: Not repaying a loan could have serious consequences that may lead to hurt feelings, decreased contact, or even resentment between you and a loved one.
  • Lenders may need that money in the future: If you don’t pay back on time or at all, this could cause your lender financial hardship if they counted on the money being repaid by a specific time. On the flip side, lending money from your own savings means it’s no longer there if you need it in the future.

Is a Friendly Loan Worth It?

A friendly loan may be worth it if you and your friend or family member are on the same page about the loan terms. It’s always best to be honest and up front about expectations and repayment terms before entering into this type of agreement.

Get the details in writing so you know you’re both covered in the event that the loan doesn’t work out as planned. Iron out the payment schedule and amount(s), potential recourse if there are any issues, and more beforehand. This will help everyone involved know what to expect, and there won’t be any surprises down the line.

Key Takeaways

  • Friendly loans are often informal money agreements between friends and family that may be more flexible than loans from financial institutions.
  • Interest rates may or may not be charged in a friendly loan, and credit checks are likely not required.
  • Putting the details in writing, such as via a signed promissory note, can help provide legal protection for you and your loved ones.
  • If interest is not charged, the IRS may consider the loan a gift. Depending on the amount, tax may be owed.