From Family and Friends to Complete Strangers: How Lending Differs

If you search for family lending, you will find many articles giving implementation advice. It is apparent that people struggle with the prospect of lending to family or friends. As such, many advice columns focus on the proper way to undergo this uncomfortable task.

As you’ve seen in our short timeline of lending in history, lending has been around for centuries. Our focus today will be a comparison of family-friend lending versus peer lending.

When lending to a family member or friend there is rarely a legal enforcer to ensure recipients will follow through with their financial obligation. Unlike peer lending, most families will not charge interest on borrowers’ loans.

Along with this, there are other issues that arise when lending to family members or friends:

1. Feeling obligated to agree to loans
2. Awkwardness that arises from initial request
3. The tedious work of making a legal agreement
4. Deciding a payment plan
5. Discussing interest on payments
6. Skirting around #2, #3, #4, #5 due to #1
7. Obtaining a lawyer to officiate
8. Loss of funds
9. Strain on relationships

In many cases, loans to family members or friends should be given out with the expectation that payments or interest will not be received.

In contrast, peer lending risks are mostly limited to one issue:

1. A borrower defaulting

Luckily, there are many ways that peer lending marketplaces can attempt to safeguard against this possibility of default:

1. Legally binding agreements to ensure payments are already built-in to each loan
2. Payments can be done in a payment plan or installment plan (depending on how large the loan)
3. Interest is charged based on the borrower’s past borrowing history (and credit score)
4. Collection agencies are utilized to resolve payment issues
5. When borrowers take out a loan their credit score is ‘hard’ pulled; which makes it more difficult to pursue another loan
6. Borrowers are required to pay late fees

Thus, peer lending differs from family-friend lending since it does not involve a direct banking presence while still being legally regulated. Peer Lending starts with a borrower going to a marketplace and requesting a loan. The loan is then funded by investors – individuals that want to invest in debt with a steady return. There are different types of borrowers to choose from based on credit history, income, location, etc. These factors all help to choose reliable borrowers and mitigate risk, which often cannot be controlled when lending to family members or friends.