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A loan from family friend

Chris Farrell Feb 3, 2009

Question: I’m turning 25 years old in a few months and am finally getting serious about eliminating my debt. I have a credit card with a $3,000 balance. It was at 24% APR until I called this summer and asked them nicely to lower it. It went down four points. Twenty percent is still too high. As our economy sours, my mom is preaching about this being a time for neighbor to help neighbor. During a conversation on the subject over the holidays, it came out that a family friend had a few thousand sitting in a savings account earning hardly any interest. She wasn’t putting it in a CD because it wouldn’t earn much more there. My mom pointed out that if Beth loaned me $3,000 to pay off my high interest credit card, Beth could earn more than one or two percent offered in a CD and I could get a lower interest rate on my debt. It’s a win-win for all parties. Laura is ready to write the check and I’m ready to lower my interest payment. Do you have any advice as to how we structure the agreement? What’s fair for all parties? Is there a precedent for this? Are there any online resources? I really enjoy your show. I learn new things ever week. Thanks for making us all better informed. Kindly, Virginia, Cincinnati, OH

Answer: Congratulations on getting rid of your debt. Now, what you’re proposing isn’t uncommon. There are a couple of important caveats. If I were writing to Beth, I would warn her to think seriously before mixing money and friendship. It’s always risky proposition. Then, assuming she’s still comfortable with it, just remember you are taking on an extra burden of making these payments no matter what. She’s a family friend.

That said, it is a favorable deal to both parties, and it’s done all the time. I strongly urge you to write-up a formal document laying out the interest rate, when the payments will be made, and when the loan will be paid off. This document will lay out her expectations and your obligation. A document like this for a small loan will also satisfy the Internal Revenue Service since she’ll be receiving an interest income from the loan.

There are plenty of do-it-yourself documents on the web. For instance, Nolo.com, a legal self help company I admire a lot, has a standard form on its website here. You could also just do one on your own. However you do it, everyone signs it. Good luck.

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