A ‘private loan’ may be a term used to describe a type of borrowing between friends or family.
With this type of loan, you make an informal arrangement with someone you know to borrow an agreed sum of money, and together you decide how and when you’ll pay it back.
How do private loans work?
This isn’t a one-size-fits-all solution. Because private loans are an informal arrangement, the mechanics of them can vary.
"There are pros and cons to private loans."
Before you agree to borrow money from a friend or family member, you’ll need to decide a few things between you, like how you’ll repay the money. This could be weekly, biweekly, monthly or on an ad-hoc basis.
You’ll also need to consider whether or not there’s a deadline to repay the full amount, and how you plan to make the repayments – cash, online bank transfer or cheque, for example.
As with any type of lending, there are pros and cons to private loans – for both the lender and borrower.
Private loan pros
1) One of the key advantages of a private loan is that, generally, you won’t have to pay any interest – unless your friend or family member decides to add a little extra on. This can make the cost of borrowing cheaper than going through a formal lender.
2) Because private loans are an informal agreement with someone who knows and trusts you, they might be more flexible. If, for example, you find yourself struggling to make a payment one month, they may let you repay less or postpone the payment.
3) Following on from our previous point, if you do make a reduced or late payment to the friend or family member from whom you borrowed, it will not affect your credit history.
Private loan cons
1) The key con of a private loan is that it has the potential to have a significant impact on your relationship if, for any reason, there are any disagreements regarding your repayments. To prevent this, it might be a good idea to put something down in writing from the off.
2) Another disadvantage is that there’s no guarantee the lender’s financial circumstances won’t change in the future. If they, for example, lost their job and had less money coming in, they might need the money they lent you back sooner than originally agreed. This could put you in a tricky position to pay back the money quicker than expected or risk your relationship with the lender.
Questions to ask
First, we’ll run through some considerations from the lender’s perspective. If you’re thinking of lending money to someone close to you, ask yourself:
- Are you absolutely confident you’ll get the money back in full?
- Do you trust the person to make repayments regularly?
- Can you afford to lend the requested sum of money?
- What action will you take if repayments aren’t made?
- How soon will you you want or need the money back?
Now we’ll have a look at some important questions for the borrower.
- Will you use the money you’re lending responsibly?
- Is your income sufficient and stable enough to commit to paying the loan back?
- What will you do if, for whatever reason, you find yourself unable to afford your repayments?
- Would it better for your situation to take out a loan with an authorised lender?
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