Borrowing & Lending, Friends & Family: Making a Sensitive Dynamic Work

John wants to buy a new car. His savings will get him part of the way to meeting the purchase price, but he’ll need to borrow money to make up the difference. Trouble is, the only auto loan for which he can qualify carries a higher interest rate than he wants to pay.

Meanwhile, John’s aunt, Betty, has money stashed in a money market account at her bank, where it’s earning virtually nothing due to an extremely low interest rate. Betty has no foreseeable need to use that money. She would prefer to have it earn more with a higher interest rate and has considered moving it into a CD, but the rates her bank is quoting for those aren’t very appealing either.

A situation such as this “can be a win-win for the lender and the borrower,” says Jason W. Dahl, a Certified Financial Planner™ at AFS Financial Group in Bethesda, MD. “If one person has excess cash that’s not earning much [in interest in the account in which it currently resides], they can earn more by lending it” and charging the borrower an interest rate on the loan that exceeds the rate that money would otherwise be earning in a low-interest-rate bank account.

Likewise, the idea of borrowing the amount needed to purchase the car with a loan from his aunt, at an interest rate well below what he could otherwise find, appeals to John. “The discounted interest rate could be a win for the borrower, too,” notes Dahl.

But is this seemingly ideal match between borrower and lender a family financial mess waiting to happen? That depends on how the people involved choose to handle the situation, according to Dahl. As appealing as the concept of person-to-person lending (and keeping the bank or finance company out of the equation) might seem, borrowing and lending money among friends or family members can sour relationships, he says. “Money does funny things to people. There’s potential for hurt feelings if you’re not really careful how you go about it.”

Here are some suggestions for turning a sensitive situation into a positive outcome for all involved:
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